Financial News and Investments

Expected return for stocks

2012-01-28T11:01:00.001-08:00

The expected return somewhere in the 7-9% range for Buffett holdings.

http://online.wsj.com/article/SB10001424052970203363504577185440666871560.html

Buffett apprentice starts strongly

2012-01-28T10:59:00.000-08:00

Strong start for Buffett apprentice:

http://business.financialpost.com/2012/0....s-strong-debut/

Infosys (INFY) Analysis

2012-01-21T22:24:00.000-08:00

Infosys (INFY) is an Indian IT services company that has world wide presence. It gets most of its business from north america (~60%) with significant revenue from Europe and a very small incremental revenue (~2%) from India.

In the last year, the return (excluding dividends) has been -25% for Infosys and overall return for the past five years has been ~-7% excluding dividends.

Let us see if this is a business worth investing in given that it is the premier IT company in India. Revenues per share have grown from 78 cents/share to $12.78/share from 2000 - 2011. Earnings have grown from 24 cents/share in 2000 to $3/share in 2011.

So, it is not the company fundamentals that have caused stagnation in the stock price. It is the unreasonable expectations of the past that have made the stock price a lot higher than it should have been given the fundamentals.

So, is infosys a good investment now? Infosys faces many challenges moving forward - especially an uncertain 2012 with economic turmoil in Europe. The company can't be termed cheap with respect to cash flow or earnings in the U.S market. There are many companies that are cheaper than Infosys in the U.S market at the moment. However, Infosys is a well run company ( no significant dilution to shareholders from 2006 onwards ) with a strong balance sheet and no debt. It should do well over the long haul.

Google Earning Analysis

2012-01-21T06:58:00.000-08:00

I went through google earnings through this table. I like to do my own analysis despite what the analysts say and come to my own conclusions.

After going through this table, the operating income grew by 11% year over year for the full year despite revenue going up 29%. It is still pretty decent but we aren't seeing the heady growth in income we saw before. Google is executing well with mobile (700K phones activated everyday), display ads (5 billion business), youtube and other businesses and will be a force to contend with for years to come. The stock valuation is a different story and it is not cheap by any means. This is keeping in mind that Google is about to buy Motorola Mobility which likely will change the MO relationship in a significant way for Android.

Since we are talking about business as a whole, let us look at the earning call transcript. From Larry Page:

Each of improved execution and velocity is focus. There are so many opportunities for Google today. But to make a real impact in the world, we need to make hard choices about where to focus our efforts.

Since we last spoke, we've announced that we're closing 12 of our products, including Buzz, Knol and Friend Connect, integrating a whole bunch of others into features of existing products. This means that we can double down on the really big bets we had made like Android, Chrome, Gmail, Display and YouTube. And I'm pleased to say this big bets are really paying off. We're seeing extraordinary velocity, the kind of velocity we only we can dream about. Android is, quite simply, mind-boggling. 700,000 phones are lit up every day. And I'm pleased to announce 250 million Android devices in total, up 50 million since our last announcement just in November. In just 2 days over the holiday weekend, 3.7 million Androids were activated. And today, we're announcing over 11 billion downloads from Android markets. Wow. Ice Cream Sandwich, which is the new Android release in October, is by far our best build yet. And our exciting new phones. I simply love my Galaxy Nexus. Superfast, it's great for photos, has an amazing 720p screen.

Chrome is on fire, too. It's a wonderful example of kind of beautifully simple, intuitive experience that really improves users' lives. People thought we were crazy. Who wants another browser? It turns out a lot of people wanted to get to web quickly and securely, and we've got an amazing, fast-growing fan base all around the world.

From the start, Gmail had security, accessibility. Get all your emails from anywhere on any device. An insane storage. That made it a winner with consumers, businesses and education. From an internal beta project 8 years ago, I'm proud to tell you today that Google Gmail now has more than 350 million active users, and it's growing rapidly. That [indiscernible] said, our merging high-use project -- products can generate huge new businesses for Google in the long run, just like Search, and we have a ton of experience monetizing those old [ph] products over time. Take Display. We brought the science of search to the art of the Display, creating a business that our latest figures show has now reached an annualized run rate of over $5 billion.

I have some exciting new numbers also for the DoubleClick Ad Exchange, spending is up over 130% year-on-year, and the number of buyers and sellers have both more than doubled over the same period. I'm very pleased with the advertising on YouTube. TrueView gives users much more choice over what they watch, and advertisers only pay when someone watches their ad.

It's not just in advertising that we're doing well. Enterprise is doing great with over 5,000 new customers signing up every day. In fact, last week, we signed our biggest ever deal, about 110,000 users at BBDA, one of the world's leading banks. All of our experience says that well-run technology businesses with tremendous consumer research, make a lot of money over the long term.

MSFT - the stock popped, should one buy more or sell?

2012-01-21T06:17:00.000-08:00

Microsoft reported its earnings this week and the stock popped as it beat analyst estimates. Let us look at the business as a whole to see if one should buy more or less?

The company's operating income for the first six months of the year decreased by ~1% and declined by ~2% in the December quarter. It is not huge but shows the business dynamics as a whole. The slow down is mostly because of the windows client slow down which will eventually show up in other businesses. However, the net income was up because of other income and a more favorable income tax rate. It didnt hurt that the number of shares outstanding declined by some 2.1%.

The other measure one must watch out for is the growth in share holder equity. The company pays out nearly 7 billion in dividends every year from its cash flows. The shareholder equity increased by about 7 billion dollars for the first six months of the year compared to June 2011. All the increase is from goodwill from the Skype purchase. Since Skype doesn't add to the bottom line yet, this increase in share holder equity will have to wait out to see how it does over time.

The company has prodigious cash flows even though it is somewhat stagnant/slightly declining year over year. The company is impacted by windows client decline but has had increases in server & tools, microsoft business division (where growth is moderating to low single digits) and declining losses in the search business. The entertainment and devices division is showing a larger decline in profits this year probably because of the acquisition of Skype.

With operating income of 27 billion in 2011 that is slightly declining year over year and not much in capex other than people that can be disposed of, a case can be made that Microsoft is under valued. However, a declining business has its own risks and there are many under valued investments available in today's market and will continue to be available. Microsoft provides a good yield that should remain reliable with increasing stock buy back even with declining cash flows. Microsoft's businesses remain solid but their hold on the market may be declining as customers flock to other form factors such as the tablet where Microsoft has been lagging.

Biglari Holdings - BH quarterly analysis

2011-08-14T09:09:00.000-07:00

BH is known as a Berkshire wannabe. Biglari Holdings reported quarterly earnings this week. Let us take a quick glance.

The way to value BH is by taking into account three components.

1. Operating cash flow

2. Investments

3. Subtract the incentive compensation part paid to the Chairman

Let us value BH based on these three components:

Operating cash flow:

The SnS brand sales growth is leveling off and Western Sizzling is going down. The top line growth went up by 3.5% and operating earnings by 10%; for the quarter both SNS amd Western Sizzling had less operating profit.

Earning before income tax was 29 million for the first forty weeks. Normalizing to 52 weeks gives a value of 37.7 million.

Investments

Investments totaled 117 million at the end of Q2. Most likely the investments have dropped since Q2 after the market adjusted. The BH group made money with FMMH.PK but the market value of CBRL has dropped since then. Anyway, we will leave it as is for the sake of this analysis.

Adjustment for chairman's compensation

Shareholders equity went up by 10% from Sept of last year, we can assume it will be up by 12% for the year. The chairman will take 1.5% of the addition in book value over 5%. This brings chairmans compensation to ~4 million.

Valuation

At the low end, we will pay 6 multiple for the earnings before income tax as the earnings are flat or declining for the restaurant business. This in addition to the investments and subtracting chairman's compensation gives us a valuation of ~340 million.

At the high end, we will pay 8 multiple for the earnings before income tax. This in addition to the investments and subtracting the chairman's compensation gives us a valuation of ~420 million.

Current Price

Using the treasury stock, we get a valuation of 580 million. Treasury stock is stock held by the various partnerships that Biglari runs under the BH umbrella. The treasury stock is used when voting for the chairman's causes but not used in calculating the EPS figure.

Without the treasury stock, we get a valuation of 450 million with a share price of $340/share.

We believe that BH is currently overvalued. Even adding back 40 million in retained earning for SnS/West and investment gains of 24 million for the next year without including chairman's compensation, we don't find BH to be a bargain even with a high multiple for earnings.

More at: http://valueinvesting.proboards.com/

TARP Warrants issues by company

2011-06-19T13:39:00.000-07:00

Company Name
JPM
Capital One
BAC-WTA
BAC-WTB
PNC
WFC
CMA
AIG
citi-a
citi-b
HIG
LNC
FFBCW
VLY
SBIB
WFSLW
BPFHW
WTFCW
TCB/WS

New forum for financial news and investments

2011-06-18T21:28:00.000-07:00

New forum for value investing at http://valueinvesting.proboards.com/

Also you can follow the value investing news at @valinvest

Why Microsoft stock is not moving up?

2010-10-03T19:41:00.000-07:00

In the past columns, we have looked at the balance sheets of several companies. In this analysis, we will take a look at Microsoft balance sheet. Let us see why Microsoft stock is not going up and is there is any prospect for it to go up significantly.

First, let us look at the top line. The overall revenue went up by about 6.8% compared to 2009 and about 3% compared to 2008. The operating income increased by about 18% compared to 2009. Let us look at division by division on how the growth looks like.

Windows & windows live:
Although the profits in windows & windows live went up by 26% compared to FY2009, the profit edged up only by 1.8% compared to FY2008. While some of this can be attributed to a weak economy, the growth of smart phones and the tablet platform may also be contributing to the slow growth.

Server and Tools:
Server and tools has done pretty well even in a tight economy increasing profits through FY 2009 and FY 2010. This division has contributed close to 5 billion in net income to Microsoft's bottom line.

Microsoft Business Division:
Microsoft business division's growth has been flat through FY 2008, FY 2009 and FY 2010. While some of the flat growth may be attributed to the new version of Office coming out, more likely than not, it is likely that the growth in this division will be in single digits.

Online service division:
Microsoft's online service division has been losing money and the gap has increased widely in FY2010. It lost 2.4 billion in FY2010 from 1.6 billion in FY2009. The increased loss is likely to be persist well into FY2011 and FY2012 as Microsoft/Yahoo partnership comes into play.

Entertainment and Devices Division:
It looks as though this division has finally turned the corner and has become profitable. It has generated 589 million in annual profit. I expect this profit to cross 1 billion in FY2011 with continued market share gains for XBox and also increased sales of the Kinect system for gaming.

Microsoft has an excellent cash position which is bolstered by additional debt. The main concern here is the use of cash. Microsoft has shown in the past that it is not very adept in using cash wisely. Thus the increased dividend is a welcome sign for the shareholders. However, the growth of long term debt is not encouraging as it increases the liabilities and weakens the company's otherwise strong balance sheet.

The main concern with Microsoft is the stagnant top line growth in its primary businesses of Windows and Office. The huge losses suffered by the online services division doesnt help the situation. The bright spot for Microsoft is the Server and Tools business. This is followed by the Entertainment and Devices division finally turning the corner.

Microsoft can increase the attractiveness of the stock to the shareholders by increasing the share re-purchase followed by increased dividend payout. As a top rated company, the payout will eventually get investor interest.

Microsoft, Google, Apple, Yahoo revisited

2010-06-20T10:49:00.001-07:00

In a previous article we looked at Microsoft, Google and Yahoo. In this article, we will look at these companies again. We have added Apple and Yahoo to the list to see how the tech industry is shaping up.

Microsoft
In the latest quarter, Microsoft had earnings of 4006 million dollars. After paying out dividends of 1139 million dollars for the quarter with a capex of 408 million dollars, Microsoft has a net accretion of 2459 million dollars. Microsoft also spent 143 million dollars for acquisitions which we wont include in this computation.

From the balance sheet, Microsoft has 39,666 million dollars in cash, cash equivalents and short term investments. Of this amount,~6000 million dollars is from short term, long term debt. Backing the debt out, Microsoft has approximately 33,666 million dollars in cash, cash equivalents and short term investments.

Google
Google had a net income of 1955 million dollars in Q1 2010. Google spent 239 million dollars in capex in the same quarter. Google doesnt pay out any dividends - this left Google with a net positive cash flow of 1716 million dollars.

Google also has cash and marketable securities worth 26.5 billion dollars on the balance sheet. While this is not the same as Microsoft, the war chest is comparable in size while being off by about seven billion dollars.

Apple
Apple had a net income of 6452 million for the first six months of the year. Backing out the capex, the income averages to 2951 million dollars for the quarter.

Apple has cash, short term securities and long term marketable securities in the amount of 41704 million dollars.

Yahoo
Yahoo had operating income of 118.7 million dollars. The company had a capex of 70 million in the same period. The net cash flow was 48.7 million dollars in that period.

The company has more than 2 billion in cash and equivalents.

Comparison

Microsoft has very robust revenue stream primarily from the windows and office franchises. The server and tools business has generated net income of about a billion dollars. The server and tools business is facing a well entrenched adversary in Oracle who recently bought Sun which gives it the range it didnt have before.

Apple is on the acendancy where the popularity of its iPhone platform has enabled it to gain market share with iPad tablets and also with Mac converts. Its overall cash balance is higher than that of Microsoft its net income is robust.

Google has a very strong balance sheet and continues to build its cash pile. Although it made a mistake in dealing with China, it has got a very strong international presence. Microsoft has 2 billion dollars yearly revenue from its online services division but is losing a dollar for every dollar in revenue. Google is closing in on 28 billion dollar in annual revenue which makes it about ten times bigger than Microsoft in the same space. Even taking over all of Yahoo's search isn't likely impact Google much in the search space. Google is increasingly becoming the dominant player in the mobile handset space by taking over market share with its Android OS. Android is expected to displace RIMM as the top OS in the smart phone space in the next three years.

Microsoft is competing in multiple markets and each of the markets, it is facing well entrenched competitors with huge war chests. The other companies are attacking Microsoft from the fringes which is likely to put increasing pressure on Microsoft's core franchises. The tech landscape is likely change significantly in the next several years with power shifting to different players in the tech space. This is likely to spur more innovation in the tech space and offer more opportunities to tech entrepreneurs.

BH - Biglari Holdings, A turn for the worse?

2010-05-09T07:04:00.000-07:00

Recently, BH (Biglari Holdings) which was renamed from SNS announced a new incentive package for the CEO and Chairman, Sardar Biglari. In the new scheme, the company plans to pay Mr. Biglari an incentive bonus of 25% of book value above 5% increase in book value every year. The matter is subject to share holder approval. Given that the name change to Biglari Holdings got 90% approval, it is likely that the change in compensation scheme will also pass shareholder approval.

Let us take a quick look at the financials to see why this deal is a good one for Mr Biglari but a bad one for the shareholders.

Looking at value line, the book value increased at 25%/year clip from 1994-1999 and at an 8.9% clip from 1999 - 2007 well before Mr. Biglari took over the reins of the company. Even if Biglari didn't do anything, BH is likely grow the book value at 8-10% pace/year. Since Biglari's compensation is tied to book value growth, the growth would have been limited to 20%/year from 94-99 and 7.9%/year from 94-99. The shareholders compounding rate will be limited because of this change.

More importantly, Biglari generated quite a bit of good will among investors for turning around SNS and improving the share holder value. However, Mr Biglari's recent actions have lost him some of the goodwill. He effected a reverse split and also named the company after himself. He will be facing headwinds moving forward. His current approach to incent himself and not have anything for his employees is likely cause problems downstream to retain talented employees.

His attempts to buy out itex and fmmh have been spurned. It is likely that future acquisition targets will continue to site the SNS case, the name change and then the compensation scheme on why future acquisitions are a bad value.

The company's intrinsic value is lower than what it was before the new incentive scheme. The company is fairly valued to slightly overpriced at current book value and taking into account the 2010/2011 estimated EPS of $15 and $18/share respectively. The EPS still likely not hit the highs of 2004-2006 at $20+/share. The compensation scheme and the fate of SNS post acquisition will reduce value for shareholders in this company.

Infosys Analysis

2009-07-04T09:18:00.000-07:00

In this account, we will take a look at Infosys, the Indian outsourcing giant that has continued to do well inspite of the economic turmoil in the last two quarters.

Infosys is an Indian outsourcing company that has done remarkably well in the past ten years. The net income after income taxes has increased from 61.5 million dollars in 1998 to 1.281 billion dollars in 2008. The EPS has also grown from 0.12 cents a share to 2.25 dollars a share in the same period. The number of shares has increased from 526 million to 570 million in the same period. The growth in the number of shares has diminished somewhat from 2008 till now primarily because of the elimination of stock option grants to employees.

The cashflow and balance sheet at Infosys is very sound. Infosys has about 1.1 billion in free cash flow yearly with about 2.7 billion in net cash in the balance sheet. Although the current economic climate may last for sometime, Infosys is well equipped to weather the storm.

Infosys employs about 100,000 people world wide with more than 75 nationalities represented. Infosys revenue grew by 35% in 2008 and 12% in 2009 in dollar terms. However, in Rupee terms, it grew by 20% in 2008 and 30% in 2009. Since most of Infosys employees are based in India, the depreciation in the value of the Indian currency has played to Infosys's advantage. During fiscal 2009, Infosys has added more clients (579) compared to the year before (538) with average sales per client coming in at 8.05 million dollars. The average sales per client has increased in 2009 compared to 2008. The revenue mix from the top ten clients has increased in 2009 compared to 2008.

From a price/cashflow basis, Infosys stock is cheaper than Google, RIMM and Amazon. However, it is also slightly more expensive than Microsoft and Apple.

Comparing companies in the outsourcing business, Infosys is cheaper than Wipro and Cognizant. However, it is more expensive than Accenture, Hewlett Packard and IBM. In the general market, there may also be better value plays than Infosys at the moment.

From a business model perspective, Infosys has fewer risks compared to tech giants such as Google, RIMM, Microsoft and Apple. Changes in technology are unlikely to hurt Infosys in any major way and may infact help increase Infosys revenues significantly.

Microsoft, Google and Yahoo!

2009-06-28T20:53:00.000-07:00

In this blog, we will look at the balance sheets of Microsoft, Google and Yahoo! to see how these companies are doing in the downturn.

In the last quarter of 2008, the market was in a freefall causing dislocations in the search, advertising businesses. Thus Q1 of 2009 provides a good picture of how the companies are doing with respect to search and advertising businesses. Let us take a look.

Google:

Google had total income of 1.4 billion dollars after income taxes. Google spent 262 million dollars to purchase plant, property and equipment. Google doesnt pay a dividend - this makes the overall cash available for other activities 1.138 billion dollars.

Yahoo!:

Yahoo!'s income from operations fell to 117 million dollars in Q1 of 2009 from about 530 million dollars in Q1 of 2008. Yahoo! also spent about 70 million on capex. Thus the cash available for other activities is about 47 million dollars.

Microsoft:

Microsoft on the other hand relies exclusively on its other businesses to fund the search operations. Let us take a look at Microsoft's online services business.

In the January - March quarter, the online services business had revenues of 721 million dollars and a loss of 575 million dollars. For the first nine months of the year, Microsoft had revenues of 2.4 billion dollars and a loss of 1.5 billion dollars.

Let us see how Microsoft's other businesses are doing to see if Microsoft can keep up these losses without impairing its ability to compete in other areas.

In the Jan-March quarter, Microsoft had 2.977 billion in net income. Microsoft paid 1.155 billion dollars in dividends in the quarter. In addition, Microsoft had capital expenditures for plant, property and equipment of 632 million dollars. Overall cash that is available after these expenses is 1.19 billion dollars.

Microsoft took a large hit in the windows client operating profits with profits dropping by more than a billion dollars because of the rise of netbooks.

Thus looking at the cash flows and the cash on the balance sheet, it doesnt look as though Microsoft will be able to unseat the incumbent Google in the search market unless Google makes mistakes and hands over the reigns to Microsoft.

The Yahoo! market cap is about 22 billion dollars. It is unlikely that any buyout can happen for less than 30-35 billion dollars. Also, the parting of Yahoo! search to Microsoft is likely to cost Microsoft good amounts of money.

Cloud platform - the next generation of computing

2009-03-22T16:36:00.001-07:00

There are several players in the cloud computing market at the moment. They vary from tech behemoths such as Microsoft, Amazon and Google to small players such as Rackspace. In this blog, we will analyze the different players and check their strengths and weaknesses.

Google offers web hosting and provides storage services through its app engine platform. However, the range of programming languages one can use with Google app engine platform is limited. The limited options also limit Google's ability to attract more programmers.

Microsoft has started offering web hosting and storage service. Currently this service is free and can be used within limits.

Offering widely used cloud services may not work well for Microsoft or Google. This business is a low margin business. While Microsoft enjoys wide margins on its productivity and operating system businesses, Google enjoys wide profit margins in its search business. The cloud business offers very low margins and it is a model that can threaten Microsoft's entire business model.

Amazon offers the best of breed cloud storage service. It also provides EC2 compute service. Amazon has also moved to offer CDN services based off of its storage engine.

Rackspace offers better pricing than Amazon in providing cloud storage and web hosting services. It also offers to host e-mail for qualified customers. Rackspace has teamed up with limelight networks to offer CDN service.

Sun Microsystems and EMC are also interested in cloud computing. Sun has historically been a player with storage technologies. EMC meanwhile has an interest in the cloud to sell more storage. It could get really interesting if IBM buys SUN. IBM would likely sell consulting services on top of the cloud software developed by SUN. There are other players such as AT&T, EDS, CSC who are also in this market.

Rackspace Systems is based off of San Antonio, Texas. It is a public company and provides details of its operations. It has been in the cloud business for some time now – its 10K shows revenue of $720/customer/year. The company doesn’t break down its profit margins for cloud vs other services ( like web hosting, hosted e-mail etc. ) The majority of the company’s revenue is through non cloud services. In fact, cloud services only make up 4% of Rackspace's market segment. However, the cloud segment is growing very quickly with 500% growth year over year. Overall, Rackspace's business is growing at 46% year over year. Rackspace has a pretax margin of 7% and after tax margin of 4%

The allure of cheaper maintenance and less capex will lure more services to migrate to the cloud in the coming years. It is difficult to predict a winner at this time, more likely than not, the winner will be a company that is not a prominent tech titan. The low margins make this model particularly attractive to companies such as Amazon and Rackspace. Others such as IBM ( with SUN ) may also find this space interesting as they add value added services and special hardware.

Bruce Berkovitz - why we sold Berkshire

2009-03-01T19:00:00.001-08:00

http://www.fairholmefunds.com/player/feb11.pdf

Bruce Berkowitz explains why he sold Berkshire.

Berkshire Hathaway 2008 Annual Report

2009-02-28T08:17:00.000-08:00

Berkshire Hathaway released its Q4 and annual report today. We have covered Berkshire in other sections in this blog. For the previous sections please take a look at this report:

The last report in this blog.

Now fast forward to the current year, will Berkshire be a sound investment for 2009 and 2010?

The company continues to be very sound and is increasing its moat in many segments of its operating businesses. Let us do a quick intrinsic value check as of 12/31/2008. If we use Warren Buffett's two column method, we have 122 billion in cash and investments + earnings per share of 3224. At the end of 2008, the intrinsic value of the company was around 110K/A share.

Berkshire as a company earns between 10-12 billion dollars a year from its various operations. This is accretive to the book value of the company. Typically, this money is invested to return 10-15% returns. It is very important to note that Berkshire is a compounding asset even when the markets are down as opposed to some of the other companies which rely on the consumer spending to rebound.

To see how the operating businesses will do, let us look at how the operating businesses did in Q4 of 2008 and equate it to 2009. In 2009, we have:

1. Insurance, Re-insurance:
This should do better than 2008. Primarily this is because of the financial position of hedge funds and other businesses having problems with capital.

2. Utility sector:
This sector should continue to do well in 2009 inspite of the economy. We can peg its earnings at par with 2008 if not more.

3. Investment and derivative gains/losses:
This should abate from its 2008 levels. My expectation is that it should start posting a gain from 2010 onwards.

4. Dividend and interest income:
I believe this should increase significantly in 2009 compared to 2008. This declined slightly in 2008 compared to 2008 but should pick up in 2009, 2010.

5. Income from manufacturing and other businesses:
This may decline by upto 20% but such a decline will reduce operating earnings by about 500 million dollars. I believe this should be made up by the gains in insurance which is gaining market share.

6. Investment portfolio:
This should recover from current position by end of 2009 or atleast in 2010.

From a three-five year horizon, Berkshire looks attractive. It looks more attractive than many other stand alone businesses which are trading at low prices in today's market.

Preferred stocks

2009-02-15T17:55:00.000-08:00

Let us take a look at what constitutes a preferred stock. From investopedia, we have the following definition:

A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.

Many of the preferred stocks are callable. Let us see what does this mean, again from investopedia:

A type of preferred stock that carries the provision that the issuer has the right to call in the stock at a certain price and retire it. Also known as "redeemable preferred stock".

The preferred stock is different than a convertible. A convertible is typically a bond that pays a certain interest that later can be converted to common stock.

When we analyze some of the preferred stocks, it is common to see the term "debenture" in the literature. Let us see what this stands for. Investopedia helps us again.

"A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital."

Now, let us take a look to see who issues preferred stocks. It is typically the financial institutions and utilities that issue preferred stocks. The banks typically issue preferred stocks as they are able to raise capital without diluting the equity holders.

Typically, a preferred is not a great investment as they may not be called on the callable date as they typically pay a dividend to perpetuity. The second problem with preferred stocks is that the dividend doesnt increase with the companies earnings but the price of the preferred may see wide fluctuations.

So, why is the preferred stock interesting? From Wall Street Journal page, many preferred stocks are generating attractive yields. Some of the banks are particularly interesting. The strongest banks in the US include Wells Fargo and USB. How do we analyze the preferred stocks? There are two tests that come to play.

1. Is the bank stable enough to pay the dividends and outlast this downturn?
2. How is the interest rate calculated? E.g: If the interest is a fixed percentage, one may lose out if the market rebounds and inflation creeps in. However, if the interest is pegged to the LIBOR, the odds of failing against inflation is low.

Investopedia helps us define LIBOR again:

The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.

Now, let us see which banks have yield against the LIBOR and which ones dont. The WSJ article shows us the current yields on preferred stocks. The yields are wider on banks with troubled assets - e.g: Bank of America and MBNA. The yields are lower on Wells Fargo and USB which have stronger franchises. The regional banks such as Suntrust also enjoy a higher yield as they are perceived to be weaker franchises compared to the larger operations.

The website Quantum Online lists some exotic securities one can follow through. Let us look at a couple of securities.

The first one is USB-L and USB-H. USB-L is currently trading at a higher price but offers about the same dividend as USB-L. While there is certainly more downside risk for both, there is a key difference between these two offerings. While offering identical yields, USB-H is trading at a significantly lower price than USB-L. This is because USB-L offers a higher yield that is fixed at a specific rate. If the inflation is to increase, USB-H will become more attractive than USB-L. From a longer term point of view, USB-H is more attractive than USB-L as USB-H offers more upside. Specifically, USB-H offers more opportunities for capital gains than USB-L.

There are other preferred stocks that one can browse in the above links. Each of them offers its own risks and rewards. One should do one's own due diligence before jumping and buying these stocks.

Amazon.com analysis

2009-01-31T23:49:00.000-08:00

Amazon's business is as follows:

We seek to be Earth’s most customer-centric company for three primary customer sets: consumer customers, seller customers and developer customers. In addition, we generate revenue through co-branded credit card agreements and other marketing and promotional services, such as online advertising.

Consumer Customers

We serve our consumer customers through our retail websites and focus on selection, price, and convenience. We design our websites to enable millions of unique products to be sold by us and by third parties across dozens of product categories. We strive to offer our customers the lowest prices possible through low everyday product pricing and free shipping offers, including Amazon Prime, and to improve our operating efficiencies so that we can continue to lower prices for our customers. We also provide easy-to-use functionality, fast and reliable fulfillment through our global fulfillment center network, timely customer service, and a trusted transaction environment.

We fulfill customer orders in a number of ways, including through the U.S. and international fulfillment centers and warehouses that we operate and through co-sourced and outsourced arrangements in certain countries. We operate customer service centers globally, which are supplemented by co-sourced arrangements. See Item 2 of Part I, “Properties.”

Seller Customers
We offer programs that enable seller customers to sell their products on our websites and their own branded websites and to fulfill orders through us. We are not the seller of record in these transactions, but instead earn fixed fees, revenue share fees, per-unit activity fees, or some combination thereof.

Developer Customers
We serve developer customers through Amazon Web Services, which provides access to technology infrastructure that developers can use to enable virtually any type of business.

It is interesting that Amazon has added a new category of customers called "Developer Customers" for whom it provides technology infrastructure to enable any type of technology business.

Amazon's top line increased by 29.19% whereas the bottom line increased by 35.5% year over year before the dilutive effects of stock options. More importantly, the free cash flow increased by 15.5% year over year, a lower rate than EPS growth. Although free cash flow increased at a lower rate, Amazon has been able to retire debt ( almost 800 million ) and increase its assets.

46.6% of Amazon's sales come outside of north america. The remaining 53.4% come from within north america. While the north america margins declined year over year, the international margins increased.

From a growth perspective, Amazon's growth in media was 20%, growth in electronics and other goods was 45% and the other segment was 29%. The total other revenue was 542 million in 2008.

Also, Amazon's shipping costs are negative. It costs Amazon money to ship goods to the customers. In 2008, Amazon spent 1.465 billion in shipping costs of which it was able to recover 835 million from the customers.

While amazon is a well run business and is doing well, the total share count has increased by about 30% in the last ten years. Amazon also trades at a price/cashflow multiple of 19, which is higher than some better run businesses in this field. The trend of increasing in share count continues to go up. Also, in this environment, there are many cheaper alternatives available to invest one's money.

Microsoft Analysis

2009-01-24T05:29:00.000-08:00

Microsoft announced FY09 earnings and employee layoffs on 22nd January, 2009.

First let us take a look at Microsoft's earning per share and margins for the last ten years. Microsoft's earning per share increased from 0.71/share to 1.87/share in the last ten years. It is expected to stay the same this year as well.

Cashflow per share increased from 0.84/share to around 2.16/share in the same period. However, the interesting thing here is the margin before income taxes. The margins declined to 39.4 cents on the dollar in 2008 from 60.2 cents on the dollar in 1999.

The number of shares outstanding declined from 10.964 billion to 9.490 billion. The company bought back stock in the open market in the last year and has further declined the number of shares outstanding to 8.914 billion.

For the first six months of FY 2009, the cost of revenue went up by 8.64%. The cost of R&D increased by 22.86%. Sales and marketing expenditures went up by 9.88%. The total expenditures increased by 10.8% for the first six months of FY09 compared to FY08.

Let us look at the revenues and profitability of each of the divisions at Microsoft.

Windows Client had revenues of 8.2 billion and income of 6.2 billion. The windows client revenue declined on a year over year basis by about 500 million. The server and tools division revenue and income increased by about 600 million making up for the downward shift in windows client. The online services business revenue increased slightly but it also opened a huge loss of 900+ million. The entertainment and devices division (includes XBoX and Zune) had flat revenue and declining profits. The cost of corporate level activity increased year over year. Consolidated net income declined to 11.9 billion from 12.3 billion dollars year over year despite increase in revenue.

Microsoft also announced layoff of 1400 employees immediately with 3600 more to follow in the next year and half. Interestingly enough, MAC gained market share against windows by about 1% point in the Oct-Dec quarter. The increase in operational expenditures will keep the EPS near 2008 levels.

As an investment, the EBT margin for Microsoft declined in the most recent quarter to about 35% from about 38%. The increase in costs continues to be a factor. Unless the company takes some measures to cut down on its various spending initiatives, it is likely that the stock will continue to underperform the broader market.

USB Analysis

2009-01-18T13:40:00.000-08:00

US Bancorp (USB) is bank with presence in north america and europe. It has the following lines of business.

1. Payment Services. USB got 27% of its revenue in 2007 through payment services segment. This segment involves corporate payment systems, merchant payment services, NOVA information systems, Retail payment services (debit, credit card) and transaction services.

2. The second segment involves wholesale banking - which earned 19% of USB revenue in 2007. This involves corporate, commercial and real estate banking.

3. The third segment involves wealth management and securities services. This accounted for 12% of USB's earnings in 2007. USB allows individuals, muncipalities and businesses build, manage, preserve and protect wealth and distribute obligations.

4. Consumer banking which involves home mortages supplied 40% of USB revenue in 2007.

This mix changed slightly into 3Q 2008 where payments accounted for 27% of revenue, consumer 41% of revenue, wealth management 13% of revenue and wholesale accounted for 19% of revenue.

Let us analyze USB with the criteria that WEB established for Wells Fargo in 1990.

a. Is the management team able?

b. Dont have a larger headcount than necessary.

c. Attack costs when profits are at record levels as they are under pressure.

d. Stick with what they understand and let their abilities, not their egos determine what they attempt.

For the first question, USB seems like a well run company without being affected by the problems in subprime and other lending despite its large exposure to the California market. Richard Davis has run the company well.

USB hasnt had any layoffs as experienced by Citi, BAC and other players. Wells Fargo also played its hand conservatively. However, its acquisition of Wachovia probably altered its asset mix.

Attack costs when profits are at record levels as they are under pressure. This is somewhat answered by no layoffs - keeping the costs under control with personnel has paid off for USB.

Finally, USB hasnt tried to swallow smaller companies using TARP money. Let us take a look at the 3Q conference call. This was an exchange between Mike Mayo and Richard Davis.

Mike Mayo - Deutsche Bank
Following up on the deal question, why wouldn’t you go out and buy another bank that’s less efficient, especially if you had a government guarantee? Also, are there certain parts of the country that you are interested in, either near or long term?
Richard Davis
Did you say “why wouldn’t we?”
Mike Mayo - Deutsche Bank
Yes, why wouldn’t you? I mean it makes sense what you have done and now the price has come down and maybe even some government assistance. Everyone asks, “what about U.S. Bancorp?” Everyone else has shown some kind of move, whether it is JP Morgan or Bank of America or Wells Fargo.
Richard Davis
I hear you. Now first of all, you know me and I am not motivated by what everybody else is doing. It only works if it works for us. The prices actually don’t come down. I mean the fact of the matter is that there is more money in the market. I suspect that the target prices might actually go up. So for us it’s just going to have to be a deal, like I said, that fits all of our criteria which is immediate accretion and long-term value. I do think that there is more of that out there. I am telegraphing that we are more active and more interested than we might have been before, but it doesn’t change any of the parameters and it doesn’t change our appetite for taking risk. It’s got to be the right deal and it’s got to make sense. So sure, we are looking at it more.

Let us look at the bank as a whole and how it compares to others.

Asset Size: 247 billion
Deposit: 140 billion
Loans: 170 billion
Customers: 14.9 million
Market Cap: 32.1 billion
Branches: 2769
ATMs: 5159

Through 3Q 2008, the ROA was 1.45% and and ROE was 16.6%. Let us see how this compares to Buffett's Wells Fargo buy in 1990. The ROA and ROE numbers were hampered by Q3 weakness. This is likely to reduce further with Q4 numbers.

Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets.

The growth in net charge offs and loan loss reserve build is expected to accelerate in Q4 2008. It is expected that the company will take 600 million in charge offs and 650 million to build reserves in Q4 2008. This compares to a total cost of 748 million in Q3 2008. While the increase in charge offs and loan losses will reduce the income, we expect the income to be still positive. The company paid out more in dividends than what it earned in Q3 and we definitely expect the dividend to come under pressure in 2009.

Risk

From Buffett's 1990 letter to share holders on Wells Fargo:

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

USB is likewise in a strong position. The recession in 2008 is more severe than the one in 1990-1991. The economy will likely continue to contract in Q1 2009 and Q2 2009. The stress in residential housing market may continue into 2009. It is likely that the stress will spread to other areas such as commercial real estate - this can put further pressure on the bank. However, there are segments of the bank that continue to do well.

TARP:

In 2008, the company received 6.599 billion in TARP payments. At a rate of interest of 5%, the company is required to pay out $330 million to the federal government every year.

Dividend payout:

Another factor is the dividend yield. While the stock paid out $1.70 in 2008, the earning as well as payout is likely come under pressure in 2009.

We expect 2009 to be a good year to invest in USB if the current market conditions dont lead to a full blown depression.

Pepsi (PEP) Analysis

2009-01-11T20:46:00.000-08:00

Pepsi has the following business segments which generate most of its profits.

Dominant in salted foods market
•36% profit from north america

Pepsi beverages
•28% of profits from north america

Pepsico International
•29% profits

Quaker Foods
•7% profits

In the last ten years, Pepsi has performed impressively. Its EPS has increased from $1.23 to $3.55 (expected ) this year. The cash flow per share has increased from $1.98/share to $4.70/share. ROE has remained stable and EBT margin has also remained stable. Overall, Pepsi has performed well in the past ten years. It has also taken the lead in US with 38% of savory snacks market and 25% of US liquid beverage market.

In FY09, the profit growth has stalled into the third quarter. From Pepsi's 10-Q:

Total operating profit increased 5% and margin decreased 1.4 percentage points. The unfavorable mark-to-market impact of our commodity hedges reduced operating profit growth by 2 percentage points and reduced margin by 0.4 percentage points. Leverage from the revenue growth was offset by the impact of higher commodity costs. The impact of foreign currency contributed 2 percentage points to operating profit growth and the impact of acquisitions contributed 1 percentage point.
Other corporate unallocated expenses decreased 2%. Lower deferred compensation costs and the favorable impact of certain other employee-related items were partially offset by higher costs associated with our ongoing business transformation initiative, increased research and development costs and foreign transaction losses. The decrease in deferred compensation costs is offset (as a reduction to interest income) by losses on investments used to economically hedge these costs.

Also, the profit growth for the first 36 weeks of the year increased 4% compared to the year before. The fourth quarter is expected to be tough with rough economic conditions worsening the down draft.

Pepsi is cheap now with a price to cash flow ration of 13 with stable cash flows. The cash flow growth may be limited for the next couple of years but may increase there after. Most of the growth will probably will come from outside the US.

I expect Pepsi to report lesser earnings after Q4 as the north america segment should see some declines given the hard Q4. Investors may be able to get Pepsi stock at better prices once the Q4 results are out.

Getting credit score information for free

2009-01-03T21:13:00.000-08:00

Saturday's WSJ suggested the following sites to check out free credit score.

http://www.credit.com

http://www.creditkarma.com

http://www.bankrate.com

Of the three sites, I found only creditkarma.com offering free credit score. Credit.com had the free score bundled with some other service.

The credit score is an approximation as the agencies that provide the scores use custom formula that is not accessible.

Berkshire Hathaway (BRKA) Analysis

2009-01-01T22:52:00.000-08:00

Warren Buffett's Berkshire Hathaway has been hammered this year by a declining share market. We have analyzed Berkshire Hathaway several times in this blog. Warren Buffett has had an outstanding record handicapping winners and has been the greatest investor of all times.

In this analysis, we take a numbers view of Berkshire Hathaway, whose earnings have been lumpy. These are the numbers from Value Line publication. From 1998 to 2008, the EPS for Berkshire has grown from 1021/share to an estimated 5685/share in 2008. The book value of Berkshire has grown from 37,800/A share to an estimated 77,420 in 2008. The insurance premiums collected per share has grown from 3606/share to an estimated 16450/share.

However, 1998 and 2008 represent vastly different times. In 1998, the bull market was hitting a crescendo whereas in 2008, the bear market probably peaked. Berkshire share scaled new peaks in 1998 where as it has hit some historic lows in 2008.

Even in this scenario, Berkshire can be conservatively valued at $110K - 120K/A share. Now, this doesnt even take into account the prospects for 2009.

Several things stand out for 2009. The most skilled investor is in charge with Charlie Munger, who is second to none. Apparently Buffett has been getting better at investing in his seventies. The bear market provides a great investor good places to put his money to work. The sage of Omaha had about 40 billion to invest in 2008 and most of the money has been invested. Assuming 10% yield, we are looking at 4B in income to bolster the balance sheet which will contribute 2500/A share. Let us take a conservative estimate and assume that the earnings will be less and will only contribute $1500/A share.

In addition, many Berkshire companies will be solidifying their position in this downturn and enhance their moats. The operating earning after the downturn is over would be significantly higher. The second thing is that many hedgefunds writing catestrophe insurance have gone belly up reducing the competition for re-insurance. Lastly, the downturn is expected to last for sometime before the full recovery. This should provide the Oracle more opportunities to invest his ever increasing war chest.

If SP500 recovers in 2009, so will Berkshire's equity portfolio. This will provide the double whammy of increasing book value, decline in mark to market losses for the put contracts expires long time from now and increased income from other SP500 companies such as GS and GE. We are witnessing the transfer of wealth from the weak to the strong.

I am betting on atleast 20% rebound in BRKA in 2009 and may be more in 2009 and 2010.

SNY (Sanofi-Aventis ) Analysis

2009-01-01T22:49:00.000-08:00

SNY is a french based company with executives from France, Germany and Britain. It has significant operations around the world. It is a dominant drug company in Europe followed by the US and the rest of the world.

It has a dominant presence in the flue shot vaccine. The company also produces vaccines for Polio/Whooping Cough/Hib, adult booster vaccines, meningitis, pneumonia, other vaccines. The company is seeing double digit growth in vaccines year over year. Vaccines make up about 10% of the revenue overall. The company is also a leader in the treatment of thrombosis ( blood clotting ) and diabetes. The main drugs of the company are Lovenox, Plavix, Stilnox, Taxotere, Elaxatine, Lantus, Copaxone, Aprovel, Tritace, Allegra, Amaryl, Xatral, Actonel, Depakine, Nasacort. The revenue jump for pharmaceuticals is in low single digits. The unfavorable dollar to euro conversion rate isnt helping the company either.

Geographically, the company has major presence in Europe with 43% of its revenue coming from Europe. 35% of its revenue comes from the US. The remaining come from other parts of the world.

The French companies Total and L'Oreal hold significant stakes in the company at 12.64% and 8.65% respectively. The companies' voting rights are at 19.06% and 14.34% respectively. The American ADR holders may not have the same rights as the share holders in Euronext exchange. As a result, it is likely that dividends will continue to get paid at increasing rates in the future.

Although the top line has been stagnant in Euros for the past three years, the operating income available to shareholders has increased. The increase has come from the decrease in "Impairment of property, plant and equipment and intanglibles" charge in the past few years.

Although the book value of the company may seem quite high, majority of the book value is in the form of goodwill and intangibles. The company acquired Aventis recently.

The company is less exposed to expiring patents and has quite a few new drugs in the pipeline. Even without the new drugs, the company sports attractive dividend yield and price/cashflow ratios.

Dell Analysis

2008-09-28T13:11:00.000-07:00

Let us look at Dell's business: From 10-K.

Dell listens to customers and delivers innovative technology and services they trust and value. As a leading technology company, we offer a broad range of product categories, including desktop PCs, servers and networking products, storage, mobility products, software and peripherals, and services. According to IDC, we are the number one supplier of personal computer systems in the United States, and the number two supplier worldwide.

Our core business strategy is built around our direct customer model, relevant technologies and solutions, and highly efficient manufacturing and logistics; and we are expanding that core strategy by adding new distribution channels to reach even more commercial customers and individual consumers around the world. Using this strategy, we strive to provide the best possible customer experience by offering superior value; high-quality, relevant technology; customized systems and services; superior service and support; and differentiated products and services that are easy to buy and use. Historically, our growth has been driven organically from our core businesses. Recently, we have begun to pursue a targeted acquisition strategy designed to augment select areas of our business with more products, services, and technology that our customers value. For example, with our recent acquisition of EqualLogic, Inc., a leading provider of high-performance storage area network solutions, and the subsequent expansion of Dell’s PartnerDirect channel, we are ready to deliver customers an easier and more affordable solution for storing and processing data.

Competition:
As a result of the intensely competitive environment, we lost 1.9 points of share during calendar 2007. We lost share, both in the U.S. and internationally, as our growth did not meet overall personal computer systems growth. This was mainly due to intense competitive pressure in our U.S. Consumer business, particularly in lower priced desktops and notebooks, as well as a slight decline in our worldwide desktop shipments (compared to 5% worldwide industry growth in desktops). At the end of calendar 2007, we remained the number one supplier of personal computer systems in the U.S. and the number two supplier worldwide.

In light of this, let us look at Dell's bottom line.

Dell's cash flow from operating activities has a stable/declining trend.

Operating
CashFlow (millions) Year

3,949 2008

3,969 2007

4,751 2006

5,821 2005

4,064 2004

In the current fiscal year, Dell's cash flow has continued to deteriorate compared to the previous year.

The primary reason for the decline is reduction in margin over the last two years compared to prior years because of intense competition. This year, the margin is even lower compared to the prior two years.

While Dell is a good franchise and will continue to have a world wide presence in the near term, the cash flow may take some hits. At the current prices, Dell doesnt look like a good investment when compared to some of the other opportunities available in the market.

Microsoft (MSFT) Analysis

2008-09-20T21:59:00.000-07:00

Microsoft is a technology company based in the US. The company is trading for a P/E of 13.46, Price/Cash flow of 11.03 and yield of 1.75%. The P/E ratio is historically the cheapest it has been.

Let us look at some numbers under the hood to see how the businesses are doing and what the prospects look like.

From the 10-K, the annual revenue for FY08 was 60.8 billion with operating income of 22.48 billion before taxes.

Fiscal year 2008 compared with fiscal year 2007

Revenue growth was driven primarily by increased licensing of the 2007 Microsoft Office system, increased Xbox 360 platform sales, increased revenue associated with Windows Server and SQL Server, and increased licensing of Windows Vista. Foreign currency exchange rates accounted for a $1.6 billion or three percentage point increase in revenue during the year.

Operating income increased primarily reflecting increased revenue, partially offset by increased headcount-related expenses, increased costs for legal settlements and legal contingencies, and increased cost of revenue. Headcount-related expenses increased 12%, reflecting an increase in headcount during the year. We incurred $1.8 billion of legal charges during the year primarily related to the European Commission fine of $1.4 billion (€899 million) as compared with $511 million of legal charges during the prior year. Cost of revenue increased $905 million or 8%, reflecting increased data center and equipment costs, online content expenses, and increased costs associated with the growth in our consulting services, partially offset by decreased Xbox 360 costs. The decreased Xbox 360 costs reflect the $1.1 billion charge in fiscal year 2007 related to the expansion of our Xbox 360 warranty coverage as discussed below, partially offset by increased Xbox 360 product costs reflecting growth in unit console sales.

The diluted earnings per share growth was impacted by the $1.1 billion Xbox 360 charge in fiscal year 2007 and current year share repurchases.

Windows client had revenues of 16.8 billion with 13 billion in income. The server and tools division had revenues of 13.1 billion and operating income of 4.59 billion. The Microsoft business division had revenues of 18.9 billion and operating income of 12.4 billion.

The remaining divisions and corporate level activity contributed to about 8 billion in losses or impairment. The other divisions include Online Services, Entertainment & Devices and Corporate Level Activity.

Overall, 59% of Microsoft revenues came from the US and the remaining from the rest of the world.

Microsoft is also in a buying frenzy spending about $12 billion in FY08 in buying companies that are publicly or privately held.

The interesting aspect of Microsoft's business is the unending investments in the search & ad space that is not yielding any fruit. More light was spilled on this in the yearly conference call.

QUESTION: Thank you. I just have some questions on the timeline here, sort of when Yahoo! collapsed. On May 3rd you disclosed your offer price of $33, on May 6th there was a quote from one of Yahoo!'s largest shareholders saying he was extremely disappointed with them. May 13th Icahn had bought a block of share. May 15th he had his board slate nominated, and my guess is by May 16th all of Yahoo!'s largest shareholders had told them that they would consider voting for the Icahn slate, and would be willing to sell for $33 a share. So that's just 13 days. It doesn't seem plausible that the asset depreciated that much in those 13 days. What really happened that made you decide not to pursue it at that point?

STEVE BALLMER: I'm glad you have the timeline, I lived it, but I don't have it sort of noted here in quite that detail. But we had a date we were going to make a decision. We came fully prepared to work. We didn't converge. There was no further I don't know, May 15th, 17th, some place in the teens, there was no it was over. The discussions stopped. Somebody wanted to sell us the business on May 15th, 17th, whatever some day was, it was unknown to me. We had a discussion. We had a discussion with the CEO of the company. We couldn't reach a deal. You move on.

The fact of the matter is, and Chris went through all of the rationale, I think, actually much more eloquently, in fact, than I did earlier in the day, and certainly much more crisply. You go through all of it, the market has changed, lots of things have changed. But we had a deadline based upon kind of what we wanted to accomplish, and time to market, and the deadline passed. And then we started looking at additional alternatives, and I know by Memorial Day we were having some discussions about a search deal, which was fine, and those, too, didn't work out. But by that time, we were really on to the search field.

CHRIS LIDDELL: I don't want to keep rewriting history, and the he said/she said sort of discussion that we've had way too much of. But when we launched the bid, we launched it with an anticipation that we would get serious engagement very quickly, and a decision very quickly. We -and if you had told me that May was going to be that point, I would have said, that's way too long. I think we made it very clear, right through the early stage of the acquisition, that something like March would have been great. The end of April suddenly became a drop-dead date. And at some point is the tipping point in all of these where it no longer makes sense to engage on the principle thing. I think we were clear right the way along.

STEVE BALLMER: It is a little weird. You could say Chris is a little bit crisper about these things than I am. But, man, we had an offer out that was 100 percent premium on the operating business of the company, and there wasn't really even a serious price negotiation until the beginning of May, which is three months later. Okay, that's just the way these things work. And yet, we had priced -you could say, why did you come in with an offer that was 100 percent premium on the operating business, but taking out the Asian assets. And the answer was, so we could get it done quickly. Chris still relatively new to tech, he said, are you kidding? No other business in the world would have this kind of patience. And yet, I think we've dealt a little bit with founders, and we wanted to give the thing some time. But at some point, as Chris said, you move on.

On the question of investing in search and related businesses:

I mean, I talked about, I think, tried to give you some characterization of what I thought that ante was. I talked a little bit about that. I talked about the potential of investing something like 5 to 10 percent of operating income for a period of time in order to go after it. It kind of gives you a little bit of a feel. We were between 5 and 10 percent this year. You could say it doesn't give you a precise feel. I'm never precise about things that are forward looking, because it doesn't seem to be all that useful, unless we're willing to be super-precise, and that's what we call guidance.

On opex cost:

Chris said maybe it made sense for me to explain just a little bit how we think about FY '09, and where we're spending money. We announced that our OPEX would be up something about $4 billion in FY '09 versus FY '08. I'm not an expert, but I bet if you back out growth in operating expenses at stores in Wal-Mart, that ranks right up there as one of the largest increases in operating expense year over year of any company in two sequential years. So let me give you a little context.

Microsoft's search business investing and the distress in the financial industry is likely to taper growth in its core businesses this year. While the share buy backs should help the earnings, that alone might not be enough.

Even though Microsoft is historically cheap, it still doesnt look like a bargain at these prices. A company like Walmart seems to offer more upside than Microsoft at the moment.

Wesco Financial Analysis

2008-09-13T14:01:00.000-07:00

This is from Warren Buffett's investment letter from 1990:

Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings. The exception was Wells Fargo, a superbly-managed, high-return banking operation in which we increased our ownership to just under 10%, the most we can own without the approval of the Federal Reserve Board. About one-sixth of our position was bought in 1989, the rest in 1990.

The banking business is no favorite of ours. When assets are twenty times equity - a common ratio in this industry - mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the "institutional imperative:" the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.

Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices.

With Wells Fargo, we think we have obtained the best managers in the business, Carl Reichardt and Paul Hazen. In many ways the combination of Carl and Paul reminds me of another - Tom Murphy and Dan Burke at Capital Cities/ABC. First, each pair is stronger than the sum of its parts because each partner understands, trusts and admires the other. Second, both managerial teams pay able people well, but abhor having a bigger head count than is needed. Third, both attack costs as vigorously when profits are at record levels as when they are under pressure. Finally, both stick with what they understand and let their abilities, not their egos, determine what they attempt. (Thomas J. Watson Sr. of IBM followed the same rule: "I'm no genius," he said. "I'm smart in spots - but I stay around those spots.")

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.

Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets. Our purchase of one-tenth of the bank may be thought of as roughly equivalent to our buying 100% of a $5 billion bank with identical financial characteristics. But were we to make such a purchase, we would have to pay about twice the $290 million we paid for Wells Fargo. Moreover, that $5 billion bank, commanding a premium price, would present us with another problem: We would not be able to find a Carl Reichardt to run it. In recent years, Wells Fargo executives have been more avidly recruited than any others in the banking business; no one, however, has been able to hire the dean.

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

A year like that - which we consider only a low-level possibility, not a likelihood - would not distress us. In fact, at Berkshire we would love to acquire businesses or invest in capital projects that produced no return for a year, but that could then be expected to earn 20% on growing equity. Nevertheless, fears of a California real estate disaster similar to that experienced in New England caused the price of Wells Fargo stock to fall almost 50% within a few months during 1990. Even though we had bought some shares at the prices prevailing before the fall, we welcomed the decline because it allowed us to pick up many more shares at the new, panic prices.

The prices are definitely not what Buffett paid for in 1990 but it still makes for a good investment.

Let us fast forward to 2008 and see how things stand at Wells Fargo. The ROA is 1.27% and ROE is 15.5%. The stock is going at a P/E of 15.9 and and a ratio of 10.8 before taxes at current prices.

The company has 47.6 billion in equity and 400 billion in loads. The debt to equity ratio is about 11. However, the conservative underwriting is helping the company weather the financial storm pretty well. The upside is somewhat lower at current prices but looking at the stock price + yield makes this stock still very attractive.

AEO Analysis

2008-09-01T09:57:00.000-07:00

AEO announced its second quarter results ending on May 3rd 2008 recently. The environment for retail has soured with the downturn in housing and the increase in gas prices, inflation.

AEO is now expected to earn about $1.41/share this fiscal year and things should improve around 2010 when the issues with women's apparel and Martin and Osa brand is fixed. Also, one should look at new product lines coming up. The American Eagle brand has reached saturation ( or about to reach saturation ) so all the cash flows must come from other brands.

Let us look at the numbers for a moment. While the top line increased by 4.5%, the bottom line decreased by 44%. ( excluding interest income ). The decreased number of shares helped hold the earnings per share somewhat respectable in this environment. The company has focussed on holding market share in this difficult period.

Management has provided guidance that the second half of the year is more likely to be like the first half without much improvement.

Let us look at some of the other things the management did. The company had 703 million dollars in cash and equivalents. In a dumb move, the company decided to hold some of the cash in auction rate securities which are illiquid. It is a move the management made most likely to get higher yield, yet management found that most of these securities are illiquid in the absence of other bidders. Now the company is forced to keep its securities till maturity. This ties up valuable cash that can be used for stock purchases held till maturity. The risk of default of the counter party is also unknown.

Deducting the 703 million dollars from the market cap, the company has 2.3 billion in market cap. ( ofcourse, this is assuming the auction rate securities will mature and can come into hand). The cash flow without including capex is around 490 million. The capex number is expected to drop next year which should bode well for this stock.

The management should aggressively buy back stock at these levels since the majority of stock buy back happened in the mid twenties. Instead of deploying the cash in dubious investments like ARS, stock buy back will provide most value for the stock holders at this time.

I still believe that the company's stock is attractively priced. The company carries no debt and has improved its inventory management. The company ships products in sixty+ countries via the internet. The gift card business provides about 4 million dollars ( annual ) revenue. If the company executes well and buys back stock, we can easily see this issue in the high twenties or low thirties in two-three years time.

Conoco Phillips Analysis

2008-08-24T13:18:00.000-07:00

Let us look at Conoco again after the rumors that Warren Buffett is doing something with the stock. We will key off our analysis from FY08 Q2 report as well as FY07 annual report.

Let us look at the proven reserves and the estimated cash flows from proven reserves. Conoco provides an estimate using 2007 year-end prices and costs (adjusted only for existing contractual changes), appropriate statutory tax rates and a prescribed 10 percent discount factor. It also assumes continuation of year-end economic conditions. The calculation is based on estimates of proved reserves, which are revised over time as new data become available. The future cash flows has been trending up primarily because of the increase in crude prices. It has jumped from 51 billion to 67 billion dollars from 2006 to 2007.

In Q2 conference call, the management said that there wont be any more major acquisitions in the near future as it won't provide additional value to share holders. Also ,at the end of Q2, the book value was close to $62/share. Of this, $20 billion came from the Lukoil investment. This has fallen somewhat since the Russian invasion of Georgia and also the subsequent oil price drop. It is likely that oil prices will remain high in the future as there are no significant new discoveries to offset depleting oil fields. COP is also in talks with Petrobras to do some joint venture in some areas ( specifics not known ). The company is also spending significant amount of cash to buy back shares.

The oil prices have since jumped up by about 15% since the end of 2007. This has led to the decline in usage of oil in the US by about 3% year over year. COP has also allocated about $10 billion to buy back its shares. This combined with the increase in gas prices lead one to believe that book value of COP will keep increasing at a steady pace through this year and next.

From a price to cashflow as well as price to book perspective, COP looks more attractive compared to the other oil majors at this point in time.

BRKA Q2 Analysis

2008-08-09T08:54:00.000-07:00

Berkshire Hathaway filed its Q2 earnings on 08/08/08. I was hoping Berkshire to report headline grabbing mark to market losses with derivatives. This would have opened a buying opportunity for me. However, it turns out that Berkshire had less mark to market losses.

Let us look at the balance sheets to see how Berkshire did.

The shareholders equity took a small drop (2.3%) compared to December 31st. Berkshire's stock holdings have taken a mark to market drop of abotu 5.5 billion in the six month period which have since recovered. In the first six months of the year, 26.7 billion of fixed income securities were bought along with 5.5 billion of equity securities. ( 11.9 billion dollar worth of securities were sold as well ) Overall, in the first six months, 19.4 billion dollars were deployed.

Let us look at the cash flow from operations. This declined to 4.99 billion from 7.43 billion from the corresponding period last year. It is a 33% drop, primarily attributable to the reinsurance market slump.

Interestingly, the interest, dividend and other investment income came in at 2.4 billion for the first six months at par with last year. This should increase in the coming years because of the large investment in the fixed income category.

Insurance underwriting gain declined this year compared to last year. The decline was across all insurance sectors with the exception of Berkshire Hathaway Primary Group. BHAC, the monoline insurer is now operational in 49 states. This sector is expected to be lumpy in earnings and very few reinsurance contracts were written in the first six months of the year.

Utilities section continues to do well with earnings fallling slightly for the quarter but up for the first six months.

Manufacturing, service and retailing continues to do wel in a tough environment. The total revenues jumped up to 17.49 billion from 14.98 billion thanks to the Marmon/TTI acquisition. Earnings also increased by 11.5%. The general trend in manufacturing/retail is that revenues are up but income is down. This is a trend across all businesses as we see increased inflation but that can't be passed on to consumers.

Finance and financial products also declined somewhat compared to the prior year. Manufactured housing, furniture/transportation leasing hasnt fallen off a cliff but are down nominally.

In general, going by strict quantitative analysis, the IV is around 142K/A share. However, IV is also the potential cash that can be taken out of the business in its life time. With this calculation, under normal economic conditions, the IV will be closer to 150-160K/share.

Sardar Biglari letter

2008-06-14T20:19:00.000-07:00

http://www.western-sizzlin.com/pdfs/Chairmans%20Letter%202007.pdf

A great letter in the Warren Buffett mould:

1
WESTERN SIZZLIN CORPORATION
To the Shareholders of Western Sizzlin Corporation:
In 2007 Western continued its evolution as a holding company in order to
maximize intrinsic business value on a per share basis.1 To achieve our objective, we
have made the conscious decision to be in the business of acquiring other businesses. To
describe our performance accurately, we must begin this year’s report with a few
comments about accounting because, depending on the percentage of voting stock
owned by Western in other businesses, under generally accepted accounting principles
(GAAP) three major categories are used for reporting our results.
GAAP dictates that we consolidate the financial statements (including income
statement and balance sheet) of businesses in which we own more than 50%. Western
Sizzlin Franchise Corp. (“WSFC”), 100% owned by Western, is an example.
Consequently, we fully record all the sales, expenses, assets, and liabilities of WSFC.
Businesses in which we own between 20% and 50% impact our income statement
in a different manner, termed the equity method of accounting. Their earnings are posted
as a single item on our consolidated income statement. For example, we have a 50% joint
venture in a Wood Grill Buffet restaurant; yet on the income statement, you will notice
just a one-line entry of our portion of profits or losses. Unlike businesses in which we
own the majority of shares, the revenues and expenses are not itemized on Western’s
consolidated income statement since we do not own the stipulated 50% plus of Wood
Grill Buffet.
Then we possess holdings in which our ownership is under 20%. GAAP
prescribes that Western cannot enter the earnings of such investees on its income
statement, and that only dividends received should be listed on it. In past years, such
investments did not affect Western’s income statement (unless shares were sold).
However, last year we decided to transfer most of our marketable securities to an
investment partnership, Western Acquisitions, L.P., in which we have limited partners
investing alongside us. Because of the limited partners, the partnership is deemed an
investment company, and accounting rules further stipulate that fluctuations of the
market price of our holdings are applied to earnings every quarter. Thus, the actual
earnings of our investees are not incorporated in our income statement; rather, the
market value changes, either up or down, are identified as part of our “earnings.” And,
to complicate matters even more, stocks that we hold outside the partnership are treated
differently; here, changes in market value affect our net worth but do not appear on the
income statement unless the shares are sold.
We have provided the abridged outline of accounting rules because Western
owns portions of businesses ranging from less than 1% of the voting stock to 100%. This
view is particularly important to positions in which ownership is less than 20% because
1 Intrinsic value is computed by taking all future cash flows into and out of a business
and then discounting the resultant number at an appropriate interest rate.
2
investees’ earnings are not recorded in our operating earnings, even though the unstated
amount may exceed listed figures. Consequently, our approach to GAAP earnings is
simple: We ignore them. Phil Cooley, Vice Chairman and my partner, and I make our
own assessment of the value of Western by accounting for all cash flows, whether we
own 1% or 100% of another concern, to arrive at Western’s “economic earnings.” It is
our ownership of our holdings and therefore our claim on cash flows that are relevant.
Accordingly, we account for the cash flows of businesses we own in whole and in part to
compute Western’s total cash flows. Our claim on the unaccounted cash flows from noncontrolled
businesses and their subsequent use is of great import to us. The growth of the
aggregate cash flows of the businesses we own — both controlled and non-controlled —
will signify the growth in Western’s intrinsic value. Our view, we warn you, is
unconventional. Then, again, our mindset is geared to pay attention to what counts and
not to how the numbers are counted under GAAP.
While we do not disclose our estimated values of the businesses we own in whole
or in part, we do provide the information you require so that you can construct your
own appraisals. We arrive at our personal valuations independent of the accounting
values for wholly-owned businesses or for the values the market places on our partiallyowned
ones. Stock market values at times are capricious, and we caution anyone about
equating them with intrinsic values.
We operate under a highly decentralized management structure with financial
decisions centralized only at the holding company. The returns on invested capital from
the operating businesses combined with my capital allocation work produces Western’s
overall return which, according to our criterion, must exceed the S&P 500 Index. Over
time, we are focused on seeking a rate of growth in Western’s business value that
surpasses the total return measured by the S&P. I am confident that the operating
businesses we own will deliver good-to-great returns on capital; my responsibility is to
reinvest the surplus cash in a manner that improves overall corporate results.
Western Sizzlin Franchise Corp.
Our largest wholly-owned subsidiary, WSFC, which franchises and operates 117
restaurants, is our main source of operating earnings.
Years Ended December 31,
2007 2006
Income from restaurant and franchise operations ...................................... $ 507,773 $ 572,210
Plus: Depreciation and amortization expense ........................................... 1,063,017 1,057,492
Plus: Claims settlement and legal fees associated with lawsuit ................ 741,287 289,109
Income from restaurant and franchise operations (excluding depreciation
and amortization expense and expenses associated with the lawsuit) ........ $ 2,312,077
$ 1,918,811
In 2007, our restaurant and franchise operations did well as profits increased by
20%. The major contribution to this heightened performance stemmed from our 50%
joint venture in Wood Grill Buffet. However, same-store sales decreased by
approximately 1% for both franchise and company-operated restaurants. While we seek
improvement in comparable sales, our approach is not simply to escalate sales at any cost
$
$
3
but to do so profitably. We want to attain increases in same-store sales through boosts in
guest traffic rather than by inflating menu prices. Thus, our focus is on understanding
customer value — by providing enticing offerings that will engender a lasting and
profitable relationship.
In 2006 and 2007 we cut unnecessary expenditures without curtailing the
services we provide our franchisees. For example, we moved offices from a venue in
which a number of offices were vacant to one that is more appropriate to our needs and,
best of all, will save us annually around $74,000 in rent. Moreover, we have trimmed a
number of like expenses to become more productive. Yet while we continue to fight
costs to save wisely, we have concurrently pursued investments in our core business to
expand franchised openings. Although these expenditures increase our operating costs,
in our mind, they are a form of investment that should supplement our long-term cash
flows. As a corollary, we must ensure the health of the existing franchise system.
Total capital expenditures for company-operated stores were $35,493 in 2007,
and in 2008 we expect them to approximate $50,000. We view these outlays as expenses
to maintain operations even though they do not appear on the income statement.
As I wrote in previous letters, lawsuits have plagued our company. In the 2005
letter I had deemed certain legal costs a one-time expense, but in last year’s letter I wrote,
“I was wrong. Shortly after the [2005] letter we were slapped with another lawsuit.” This
litigation has cost us nearly a painful $1 million. As an investor, when I see the term
“one-time” expense repeat every few years, I no longer designate it as “one-time,” but as
“habitual.” In our case, the recent significant legal liabilities stemmed from past years
when WSFC’s former management made the unsound decision to lease properties under
unfavorable terms. Because of the failures to recognize and remedy past problems, I
have made the decision to become more involved and to that end have assembled the
appropriate legal counsel. As for future exposure to litigation, we now have only one
more sublet arrangement (expiring later in the year), and we are assiduously working
through any issues to avoid future liabilities. Consequently, by the end of the year we no
longer will need to report the expense line “subleased restaurant property expenses.”
In my view, we are displaying signs of progress. We are pleased that in December
2007 a new franchisee started an updated yet still traditional Western Sizzlin concept with
a smaller footprint. This Parkersburg, West Virginia store is expected to generate sales of
approximately $3 million in its first year of operation. The unit economics are very
attractive with a sales-to-investment ratio of 1.5:1. In addition, a newly recruited
franchisee in California later in the year will introduce the first Wood Grill Buffet there.
Whether the store is a Wood Grill Buffet or a Western Sizzlin, we are happy with the unit
economics for a franchisee. Because we have proven concepts, our key task is to
encourage potential operators to learn that these outlets are accessible and lucrative. (Call
Jerry Plunkett at 540-345-3195 if you’re interested in becoming a restaurateur
representing our brands.)
We entered into a joint venture in 2005 to build a single Wood Grill Buffet
restaurant of 12,600 square feet, seating 400, located in Harrisonburg, Virginia. This
venture has been exceptional mainly because of our partner in the project, W.E. Proffitt,
who because he knows how to run a buffet concept to perfection, lives up to his name by
producing exceptional profits. W.E. has day-to-day operating responsibility for the
business. The decision to team up with W.E. was easy, given his success at his other
4
restaurant located in Charlottesville, Virginia, which is also generating around $5 million
in revenue.
Below is the result for the Wood Grill joint venture for 2007:
Year Ended
December 31, 2007
(unaudited)
Statement of Operations Data:
Total revenues ............................................................................. $ 4,960,695
Food............................................................................................ 2,110,602
Labor........................................................................................... 1,502,077
Marketing.................................................................................... 204,374
General and administrative .......................................................... 404,106
Depreciation and amortization ..................................................... 200,869
Interest ........................................................................................ 223,574
Earnings (loss)............................................................................. $ 315,031
In partnering with W.E., we formed a jointly-owned entity that borrowed $3.3
million with each partner contributing $300,000 in capital for a total investment of $3.9
million, which includes land and building. Western also guaranteed 50% of the bank
loan. Last year, earnings before interest, depreciation, and amortization but after capital
expenditures were $726,479. The return on invested capital was 18.6% with a free cash
flow2 return on equity capital of 83.8%.
Needless to say, we like the unit economics of Wood Grill, and as evidenced by
our experience, we think it can make an effective operator a healthy stream of income.
It’s a concept based on the sound premise of delivering great values to consumers, whose
patronage in turn delivers great returns to the owners.
Mustang Capital
We are in the process of purchasing 51% of Mustang Capital for $1,173,000.
John Linnartz is the founder and managing partner of Mustang, an investment
management firm with approximately $55 million in client assets. (For sharp-eyed
readers, we are technically purchasing a 50.5% limited partnership interest in Mustang
Capital Advisors and a 51% membership interest in Mustang Capital Management, which
owns a 1% interest in Mustang Capital Advisors as its general partner.) Western plans to
pay a total purchase price of $300,000 in cash and $873,000 of Western’s common
stock, priced at $16 per share.
I met John a few years ago at a Christmas party held by an accounting firm
servicing our respective investment companies. As two value investors, John and I
naturally gravitated to a corner to discuss pink sheet stocks. His knowledge is impressive;
as a sample, I gave him a few facts about a certain stock, and he identified the company
simply through my sketchy data.
2 Free cash flow represents earnings plus depreciation and amortization minus capital
expenditures.
5
The next time I saw John was last year in New York at Western’s annual meeting,
as he then was one of our largest shareholders. Several months later he asked for a
meeting and broached the idea of Western’s purchasing his business, a proposition I
immediately embraced. To John, price was not the primary factor; rather, he wanted a
good home for his business and also wished to continue running it. His investment
record, founded on a very stable client base, is phenomenal. He will continue to operate
his business as before.
We believe that other money managers like John would find Western an ideal
solution to monetize a portion of their business, establish a succession plan, and be part
of a public company without being saddled with all the drawbacks: e.g., meeting with
analysts, regulatory filings, press interviews, and so on. Furthermore, they could
continue to run their business as they had before we purchased them. Phil and I are
excited about the prospects of working with John, and we expect that Western
stockholders will be equally excited about the value added from this acquisition. If you
plan to attend the annual meeting, be sure to say hello to him.
(Mustang, through its funds and its managed accounts, held approximately 7.2%
of Western's common stock. However, at the closing of the transaction, Mustang’s funds
will distribute Western’s stock to their limited partners.)
Friendly Ice Cream Corp.
In my letter to you last year, I wrote concerning our plans for one of our then
largest equity positions, Friendly Ice Cream Corp. Shortly after writing you on June 8,
2007, a week later, the company agreed to be purchased by Sun Capital Partners, a
private equity firm, amounting to $15.50 per share or $337 million (which included the
assumption of debt). Because of Massachusetts law, which requires the affirmative vote
of the holders of not less than two-thirds of the outstanding stock to approve such a
transaction, Sun indicated privately to us that unless we contractually agreed to the offer,
it would not buy Friendly. Because the price reflected full value and it was the right
decision for all shareholders, we concurred with the transaction.
Friendly was a fascinating situation for Phil and me. It epitomized our love for
great businessmen like Friendly’s co-founder, S. Prestley Blake. Moreover, we were not
the only ones who thought Friendly’s situation was thought-provoking. Harvard
Business School made our proxy fight and Prestley’s lawsuit with Friendly’s top
leadership the subject of a case study. Professors V.G. Narayanan and Fabrizio Ferri
along with Senior Researcher James Weber wrote an extraordinary study, adhering to the
facts with admirable accuracy. You may order a copy of the case by visiting
http://harvardbusinessonline.hbsp.harvard.edu. I will refrain from recounting much of
what you can read in the case.
We started purchasing the stock for Western in July 2007, accumulating 531,318
shares by the end of 2007 at an average price of $8.54. This purchase price in relation to
the buyout amount was approximately 82%.
6
The Steak n Shake Company
Around the time Friendly announced its intentions to sell, we began investing in
another restaurant chain that like Friendly boasted an iconic brand but had also fallen on
hard times: Steak n Shake.
The company was started in 1934 by A. H. “Gus” Belt. In the years since its
founder passed away in 1954, the ownership has changed hands three times. Luckily for
the business, in 1981 E.W. “Ed” Kelley sealed the contract to purchase the company and
began to grow it. Over the next two decades under Kelley, the chain snowballed into a
great restaurant company. Unfortunately, Kelley’s decline in health in 1998 reduced his
role in the firm, and the health of the company began to deteriorate. For the next ten
years, the company increased its top line but failed to create shareholder value for the
capital that it retained in the business.
Observing that the firm’s predicament had culminated in lowering its stock price,
I allotted capital from Western to purchase shares amounting to 5.4% of Steak n Shake.
The ownership reported in our public filings, however, is 13.2% because of The Lion
Fund, L.P. and other shareholders who are acting in concert with Western. Consequently,
our group represents the largest stock ownership in the company. Members of the group
consist of a couple of Ed Kelley’s former business partners, one of whom includes the
former Vice Chair of the company, S. Sue Aramian, Mr. Kelley’s right hand person.
On August 13, 2007, Phil and I traveled to the company’s headquarters in
Indianapolis, scheduled to visit with Peter Dunn, then CEO, and Jeff Blade, CFO. Thirty
minutes before our meeting, we read on the wire that Mr. Dunn had resigned. Alan
Gilman, at the time chairman of the board, was appointed interim CEO. Consequently,
we met only with Messrs. Gilman and Blade, and by the end of the meeting we asked for
two board seats to help restore and unlock the value inherent within the company. After
several months during which the desired results were not forthcoming, we initiated a
proxy contest. In addition to mailing letters to shareholders, we set up the website
enhancesteaknshake.com to communicate with all stakeholders.
Of course, a proxy fight is only a prelude to improving the performance of a
company. The proxy contest accomplishes a change in the boardroom, which alters the
dynamics of the leadership in a company. To us it was the last resort, but one that we felt
forced to take; Steak n Shake’s former leadership had lost sight of its purpose.
In proxy contests, several proxy advisory firms are in business to advise
institutional investors on how to vote. Phil and I received the backing of all major
advisory firms: Institutional Shareholder Services, Glass Lewis & Co., Proxy
Governance, Inc., and Egan-Jones Proxy Services. The net effect at the annual meeting
on March 7, 2008 was that these recommendations along with the support of
shareholders eventuated in our winning two board seats in a landside with 74% of the
votes cast in our favor.
Steak n Shake’s intrinsic value per share has been declining. While the economy
provides a difficult environment for restaurants, the company’s performance is
unacceptable. What attracted us to Steak n Shake was the power of the brand, its real
estate, and the chain’s ability to generate substantial cash inflows. Even though Steak n
Shake has experienced larger operating shortfalls than I anticipated when I began
7
purchasing the stock, its problems Phil and I believe are fixable. Thus, we believe in the
company’s long-term prospects.
The former management’s revenue strategy in the new millennium — to grow
top line without achieving the proper return on invested capital — was fallacious. Theirs
was a case of opening stores without the proper management systems and operational
capabilities in place to execute effectively, a mistake culminating in low returns on
invested capital. Nevertheless, we think that the situation can be remedied if the
principles, objectives, and alterations we have in mind are implemented.
The primary objective of Steak n Shake’s board and management must center on
intelligent ways to maximize the intrinsic business value of the company on a per share
basis. This long-term view will keep leadership disciplined to create value on an
enduring basis. Otherwise, it is easy to become myopic — with detrimental results. It is a
requisite to begin to implement certain strategic initiatives to create substantial and
sustainable shareholder value. The reasons underlying these imperatives are that the
record clearly shows, in quantifiable terms, that during the last ten years approximately
$566 million in capital has been spent, yet operating profit declined and negative
shareholder returns were produced!
Steak n Shake has exemplified the antithesis of a value-based strategy, proving
that sales growth is not tantamount to value growth. Growth at a competitive
disadvantage — when cost of capital exceeds return on capital — destroys shareholder
wealth. The decision to plow money back into low-return investments has resulted in the
detrimental effect of lowering the price of the stock. A larger company has been created
with more company-operated restaurants, but shareholders have been denied the
opportunity to reinvest their capital elsewhere in more remunerative opportunities. In our
proxy contest, we advocated that a moratorium be placed on new store openings.
We continue to espouse the notion that the company focus on the generation of
free cash flow and the judicious reinvestment of capital, a policy intended to maximize
the value per share of the company. It can no longer allocate capital without considering
opportunity cost. If intrinsic value per share increases, the stock price will eventually
follow suit.
In pursuit of optimizing free cash flow, the uppermost levels of leadership must
constantly review projects and eliminate the unnecessary ones to curtail nonessential
spending. Equally important is to take the savings from excess spending and reinvest
Steak n Shake’s Capital Allocation Record
($ in thousands)
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 10 Yr.
Change
Revenues $295,944 $350,879 $408,686 $445,191 $459,014 $499,104 $553,692 $606,912 $638,822 $654,142 $358,198
Growth per Yr. – 18.6% 16.5% 8.9% 3.1% 8.7% 10.9% 9.6% 5.3% 2.4% –
Pre-tax Profit $ 32,850 $ 30,602 $ 33,204 $ 32,366 $ 36,044 $ 32,424 $ 42,438 $ 44,444 $ 42,292 $ 14,871 ($17,979)
Growth per Yr. – (6.8%) 8.5% (2.5%) 11.4% (10.0%) 30.9% 4.7% (4.8%) (64.8%) –
% of Revenues 11.1% 8.7% 8.1% 7.3% 7.9% 6.5% 7.7% 7.3% 6.6% 2.3% (8.8%)
Capital
Expenditures
$ 51,430
$ 66,974
$ 75,765
$ 39,910
$ 41,351
$ 30,707
$ 46,278
$ 63,622
$ 80,840
$ 68,643
Cumulative Capital Expenditures (10 Year Period): $565,520
Source: As Reported in SEC filings
8
those funds prudently. Complying with the maxim to save wisely and invest sensibly is
imperative to turn Steak n Shake around. But turnarounds cannot turn without
management’s reducing unnecessary overhead. General and administrative (“G&A”)
spending must be limited to appropriate levels. The reduction in G&A should become
part of the corporate culture at Steak n Shake to conserve resources and to distribute
them productively.
Towards that end, just returning to past G&A levels — on a per unit basis —
would save the company around $15 million annually. Bottom line: Steak n Shake like
WSFC is in the penny-profit business. We continue to believe that a great deal of money
has yet to be saved at Steak n Shake’s headquarters and at the store level.
In altering the corporate culture, we must select an entrepreneurial CEO who will
be relentless in fighting costs, who will concentrate on the customer by leading
employees and franchisees to champion a common standard of quality, service, and
cleanliness. The culture of the organization should revolve around capitalizing on the
mental prowess of entrepreneurs. With the right leadership team, the company can
become more nimble and inventive as it adheres to principles and practices placing a
premium on individual performance.
The CEO must be a vigorous leader willing to instigate grassroots searches to
improve operations. Steak n Shake must adapt to the very sharpest ideas and practices
pervasive in the marketplace. Borrowing or emulating the most effective industry
methods is essential to molding a profitable restaurant chain. As Wal-Mart founder Sam
Walton once said, “Most everything I’ve done I’ve copied from someone else.” At Steak
n Shake, we can learn a great deal from other highly resourceful retail and restaurant
businesses.
We want Steak n Shake to be best-in-class in product, in menu, in customer
metrics, and in financial returns. Every day, roughly a quarter of a million people go
through Steak n Shake restaurants; the quality of their overall experience will ultimately
determine whether they will increase or decrease their number of visits. The pleased
guests will certainly spread the good word that their listeners ought to visit frequently,
whereas the displeased guests can hugely damage future traffic. An organization that is a
standout for its employees, franchisees, and customers will ultimately be a standout for
stockholders.
Current plans must focus on turning around operations with unit economics that
are attractive for the company and its franchisees. Over the longer term the company
should strategically zero in on growth through franchising. Franchising represents a
strategy of disciplined unit growth by leveraging the brand with market penetration in a
manner that begets low-risk revenue and high-return cash flows. Such a long-range plan
would yield numerous benefits: It would allow management to concentrate on propelling
the value of the brand by allotting more resources to development of better products,
improved quality control, shrewder marketing practices — all resulting in better overall
productivity, resource allocation, high returns on capital, and significant free cash flow.
Thus, the company should be in the franchising and real estate businesses for the cogent
reason of maximizing return on capital while concurrently minimizing cost of capital —
a powerful combination that would lead to creating value for all shareholders.
9
Improvement of store-level profitability, growth through franchising, reduction
of corporate G&A, focus on generation of free cash flow, share repurchases, pay-forperformance
compensation, a more effective governance board — these are strategies we
have in mind to enhance the value of the company. Western’s 5.4% equity interest in
Steak n Shake represents about $33 million of revenue, larger than WSFC’s entire
restaurant and franchise operations. Consequently, we are working with the board so we
can become more involved with the company, effect necessary changes, and invite in the
right CEO.
Thus far, the investment result has been dismal. But we think that it will improve.
ITEX Corp.
ITEX is in the business of barter, functioning as the clearinghouse for
approximately 24,000 member clients through a franchise network. Barter is the oldest
form of commerce, so we are going back a few thousand years with this concept. Instead
of businesses bartering directly with each other, ITEX provides a marketplace for its
member clients to purchase goods and services from one another utilizing trade credits,
which are administered through ITEX’s bookkeeping system. Thus, ITEX manages the
marketplace and acts as a third-party record-keeper, charging its members a percentagebased
transaction fee as well as an association fee.
By now you may wonder why one would use ITEX when ages ago a convenient
medium of exchange had been invented, money. ITEX has in essence an alternative
monetary system using its own unique currency. ITEX’s exchange, or bartering, can be
another source of revenue for most businesses, particularly those with excess inventory
or capacity. Instead of unused products lying fallow and services remaining
unproductive, bartering opens the door for firms in like situations to work with one
another. Thus, it’s an effective way to enter new markets or reach clients who otherwise
may not have paid cash. I myself have been using barter services since I was 13 years
old. ITEX helped me launch my early ventures. In fact, years ago I paid for office rent
and obtained office furniture all through the barter exchange. At our operations in
WSFC, we have been utilizing the bartering program since early 2007.
ITEX’s business is attractive to us because, as a franchise system like WSFC, it
generates stable cash flows and pleasing returns on capital. Initially, we sought to
purchase the entire business, making an unsolicited tender offer at an exchange ratio of
.06623 shares of Western common stock for each outstanding share of ITEX’s common
stock. While we believe the value of ITEX would be enhanced as a wholly-owned
subsidiary of Western, for reasons such as elimination of redundant public company
costs and potential revenue sources, ITEX management vehemently opposed the
transaction. Nonetheless, we proceeded, and we thought we probably would have
succeeded if we upped our offer, a move which we vehemently opposed (for reasons we
explain in the next section). But the shareholders who did wish to tender their stock were
given the opportunity to do so as we revised the offer and in the process increased our
ownership by 5% of the company. We had previously purchased 4% in the open market
with cash. Therefore, we currently own approximately 9% of the company and are its
largest outside shareholder, a position that leaves us quite comfortable.
10
Stock Issuance
Because our goal is to maximize the value per share of Western, we are
concerned both with the numerator, intrinsic business value, as well as the denominator,
the number of shares. When considering a share issuance in purchasing a business, we
follow a basic policy: We will issue shares only when we receive as much or more
intrinsic value on a per share basis. What concerns us is not whether an acquisition is
accretive to earnings per share but whether it adds to intrinsic value per share.
In negotiated acquisitions, the price paid often is so high that any potential
benefit to the buyer is negated. In our analysis we have found that acquisitions
predicated on cost savings usually have a more successful outcome than do ones based
on revenue generation. Unfortunately, synergy often has been used as a pleasant word in
mergers and acquisitions to justify a premium when in fact synergy did not exist. A
significant premium, incidentally, is not necessarily a concern if it can be defended. We
do not look for acquisitions on the basis of synergy; rather, we seek to capture the value
of non-integration. Non-integration has value, and as a holding company we plan to
capture that value in allowing acquirees to retain their autonomy. The cost is lack of
synergy, which we believe is overrated, whereas non-integration is underrated.
Acquisition Goals
We will continue to seek ownership in businesses in their entirety as well as in
part. When purchasing a controlling interest, we will do so only at a sensible price. While
we remain flexible in structure, our basic criteria for a business acquisition are that the
acquiree comes with intelligent management who has historically produced healthy cash
flows and earned high returns on invested capital. Therefore, we are not interested in
somewhat chancy new ventures, as promising as they may appear to be.
If the principals in a business are interested in becoming a part of Western
companies, we would welcome hearing from them.
Western Real Estate
Western purchased 23.5 acres of land in San Antonio through Western Real
Estate, L.P. on December 13, 2007 for $3.75 million. The property is near an 800-acre
mixed-use development, The Rim, in one of the most robust and fastest growing areas of
the city. We knew that all 23.5 acres were not usable, but after the due diligence we
received reliable data and was in a position to offer a price and close on the transaction
expeditiously. The price was favorable in relation to the property’s potential usability.
We received attractive financing from our friends at Wachovia Bank. They have
provided a $2.6 million note at prime minus 50 basis points, which at the date of this
letter stood at 4.5%. We are delighted with the after-tax carrying cost of around 2.8%.
Thus far, we have not accepted outside money for Western Real Estate, L.P. although
certain parties remain interested.
The entitlement process began as soon as we purchased the property; of course,
this process will increase our costs but eventually should lead to sufficient cash flows
when compared to our total investment. There is value in converting non-income
producing real estate to one that is producing. With many of our investments, but
11
particularly with real estate development, it pays to follow Benjamin Franklin’s advice:
“He that can have patience can have what he will.”
NASDAQ Listing
Earlier this year, on February 25, 2008, Western’s shares were listed on the
NASDAQ Capital Markets and now trade under the symbol WEST. Our decision to list
on NASDAQ was driven by our desire to reduce the transaction costs for our
shareholders.
Over the long haul, the most investors can earn from a stock is equal to the
profits achieved by the business less transaction costs, namely the commissions charged
by brokerage firms and the net spreads realized by market-makers. We attempt to attract
long-term shareholders who seek to profit in concert with the business and not from the
faulty reasoning of their co-shareholders on the value of the company. Irrespective of
the exchange on which the stock is listed, we have connected with the right shareholder
base. Phil and I have been pleased by the quality of our shareholders — savvy long-term
business owners. Because we view Western as a medium through which shareholders, not
the company, own the assets and claim the profits, we are ultimately concerned about the
pre-tax return of our shareholders.
The legal and listing fees in connection with our presence on NASDAQ were
approximately $90,000 and expensed in the first quarter, 2008. We expect that this
amount is far less than the long term savings on our shareholders’ transactions. Clearly,
we are not income statement driven, but rather we are concerned with the long-term
economic consequences of our decisions for our shareholders.
Board of Directors
In 2007 we added two new board members: Kenneth R. Cooper and Martin S.
Fridson. Ken, a real estate attorney who has been a trusted friend, is also able to proffer
valuable assistance with Western’s real estate transactions. Marty is the master when it
comes to the junk bond market. Marty and Phil knew each other over the years, at one
point serving simultaneously on a non-profit board. I first learned of Marty when I was
an undergraduate student in Phil’s investment class because Phil required his entire class
to read Fridson’s book Financial Statement Analysis. Last fall, Phil and I visited with
Marty about his joining Western’s board, and shortly thereafter he enthusiastically
agreed. While I enjoy all of Marty’s writings, I recommend your reading his latest,
Unwarranted Intrusions: The Case Against Government Intervention in the Marketplace,
one of my favorite volumes from 2007.
Rights Offering Redux
Last year I offered an explanation of the use of a rights offering, which you can
read by accessing the letter on our website.
In 2007, as in 2006, we initiated a rights offering. We raised $7.6 million in 2007
and $4.2 million in 2006. In both years Western did not hire an investment banker to
assist with the rights offering. As I mentioned in last year’s letter, flotation costs (namely
issuing expenses, e.g., legal, printing, accounting, and numerous smaller associated
outlays) would be quite low in 2007. Actually, expenses were remarkably low at 1.3% of
issuance, resulting in net proceeds of $7.5 million.
12
Phil and I are puzzled why more companies do not initiate rights offerings
because it is an excellent method to raise equity capital and minimize costs. (No
investment banker fees perhaps!) When boards and management review their alternatives
in equity financing, they invariably opt to sell discounted shares to outside parties along
with paying high underwriting fees — the effects of both are to the detriment of their
shareholders’ net worth. Not only are flotation costs much lower in rights offerings than
they are in most other forms of equity offerings, but they are a quite equitable method
and provide all shareholders equal terms.
* * *
As the former CEO of Coca-Cola, Roberto Goizueta once articulated, “We, in
business, do have a calling. We have a calling to reward the confidence of those who
have hired us — and to build something lasting and good in the process.” This is our
guide as we attempt to grow Western’s value in many dimensions. We seek to utilize all
available options to create value. We have a strong balance sheet and plan to conduct our
affairs in a manner to maintain extreme flexibility. We are willing to trade near term
performance to maximize long-term value and in the process strengthen Western.
However, we should warn you that our methods will produce erratic results but ones we
believe will be above par in the long haul. If volatility in operating performance
unnerves you, then Western’s stock is not for you.
Annual Meeting
Our annual meeting will be on Wednesday, July 9, 2008, in New York City at the
St. Regis Hotel. Annual meetings represent ideal times to communicate with a number of
shareholders simultaneously. The bulk of the meeting will center on answering your
questions. We will begin at 1:30 pm and continue until all your questions are answered.
To be fair to all shareholders as well as to be efficient with our time, the annual
forum is a surrogate for one-on-one communication. While we cannot respond to
individual inquiries throughout the year, we will gladly spend as many hours as
necessary to answer shareholder questions at the annual meeting.
We have attempted to set forth our principles in this as well as in past letters and
hold annual meetings that are informative. I find our annual letters and annual meetings
to be practicable media to attract like-minded shareholders who embrace the
multidirectional nature of Western’s future. Because the management of most companies
is consumed by quarterly computations and pursue targeted, preconceived results, they
attract shareholders with similar time horizons and expectations. We, on the other hand,
think in terms of decades. Of course, quarterly and annual performances are important to
us but not at the expense of generating higher long-term value. Our approach may be
unconventional, but we find it to be more productive and sensible than conventional
methods.
We look forward to welcoming you on July 9th.
Sardar Biglari
June 10, 2008 Chairman of the Board

Berkshire Hathaway Q1 Analysis

2008-05-03T10:38:00.000-07:00

In this article, we examine Berkshire Hathaway's Q1 numbers and try to put an intrinisic value around the business. First, we will look at Berkshire's performance relative to SP500. Secondly, we will look at the strength of operating businesses. Then we will take a look at new investments. Lastly, we will take a look at overall outlook for the business.

The SP500 index dropped by about 7% in Q1 of 08. Compared to this, Berkshire's share holder equity dropped by 1.2% in the same period. So Berkshire handily out performed SP500 in Q1.

Let us next look at the operating businesses and cash flow. The insurance premiums earned declined by half - this is primarily because of the decline in premiums in the Berkshire Hathaway ReInsurance Group. Overall, there was a 22% drop in revenue. In the utilities sector, there was a slight gain in the mid american unit. In the finance/financial products sector, there was a mark to market loss of 1.6 billion. It is unlikely that this loss will be realized as the losses are on a logn term PUT option that is unlikely to be paid out. Taking this out, the Q1 earnings are roughly comparable to Q1 of last year.

Of all the businesses reported, Berkshire Hathaway Reinsurance Group has reduced the number of policies it is underwriting which contributes to the decline in revenue. Other operating companies have continues to do well in the face of a tough economy. Not writing insurance policies when the pricing environment is not right is a good way to operate the business. So, this points to good underwriting practices.

Then, the last piece of the puzzle is investments. From the balance sheet, the cash flow from operating activities declined to 3.3 billion from 4.6 billion for the quarter. On the other hand, 10.5 billion dollars were deployed in fixed income securities in the quarter. 1.5 billion was spent on equities. 4.8 billion was deployed to acquire Marmon group with further capital outlays in the future. Cash and cash equivalents declined by about 9 billion dollars in the first quarter. It declined by about 10.5 billion on a year over year basis. With another six billion pledged for the Wrigley deal, the 30 billion dollar barrier is close to being broken. If the bear market is prolonged as Buffett thinks, it is likely that more investment opportunties will arise for Berkshire and money will be deployed.

The IV of the company is 147K per my estimates as of end of Q1. It should be around 155-160K range as of now because of the stock market rebound. If the stock drops, it should provide a great entry point this year.

In case of a dip in the markets next week, it may present a great buying opportunity for a company which will continue to grow in the 10% range in the long term.

Berkshire Hathaway FY2007 Analysis

2008-03-01T20:42:00.000-08:00

Berkshire Hathaway (BRK) reported its yearly earning on Friday, 29th of February. The comapny did well, advancing its book value by 11% compared to 2006 and beating SP500 handily. SP500 returned 5.5% in the same period. Berkshire has beaten SP500 for three years in a row now.

Some special notes from Buffett's letter:
Return on invested capital on See's candy - 200+%
Return on capital in Flight Safet - 27%
Return on capital in Microsoft - ~100%.

See's candy is a better business than Google or Microsoft, though a lot smaller in scale :-). Microsoft's profit margins and return on capital likely will continue to erode.

The other point of interest is the value of stocks owned by Berkshire is now 75 billion dollars. There are several that will do well in the next three-five years, some probably by a huge margin. In the mean time, they will kick in dividends to Berkshire in the range of a billion+ dollars a year. The stock portfolio will be at 95 billion with just 8% return in the next three years.

Warren Buffett has invested about 27 billion dollars in the last two years. All the free cash generated in the last two years has been deployed and will continue to get deployed in the next two-three years. I expect the free cash on the balance sheet to decline on a year over year basis in the next two-three years. The way cash is generated, even if the cash is deployed in the last three year's pace, we are looking a total of around 65 billion dollar investment from 2005-2010 inclusive. If one gets a return on capital of 10%, ( 10.8% is Berkshire historical record ), one an look at earnings going up by about 30%. Meanwhile the stock portfolio should also increase by about 25-30% excluding dividends.

I put my intrinsic value between 148-156K for berkshire at the end of 2007. It should be possible for the IV to go north of 200K by the end of 2010. This is a conservative estimate and the actual returns could be much higher.

CarMax KMX Analysis

2008-02-17T11:32:00.000-08:00

KMX is mostly a used car dealer with attention to quality, no haggle pricing and low prices. It offers to remove the hassle in used car buying. I checked out the carmax.com website and the prices for the cars I saw were cheaper than the ones available with the dealer. KMX also has four new car selling facilities. Given the mix of new vs old cars ( 30-70 ) as well the expansion plans of KMX, it is likely that KMX will continue to see volumes of scale as it expands.

KMX was spun off from circuit city stores in 2002 as an independent entity, KMX was founded in 2002 in Virginia and currently has 81 stores in the country with most stores in Florida, Texas followed by California. Florida and California are hit heavily by the falling house prices and the general economy continues to cool off with impact on consumers. Let us see how this impacts KMX. The new car sales dipped in 2007 ( 11%) where as the used car sales went up (20+%). As the economy cools, it will be interesting to see how the mix changes in the first couple of quarters for KMX.

KMX has another revenue stream through auto financing operations. The company provides the following guidelines for 2008.

Fiscal 2008 Expectations
The fiscal 2008 expectations discussed below are based on historical and current trends in our business and should be read in conjunction with “Risk Factors,” in Part I, Item 1A of this Form 10-K.

Fiscal 2008 Sales. We currently anticipate comparable store used unit growth for fiscal 2008 in the range of 3% to 9%. We also expect wholesale unit sales growth to be consistent with our total used unit sales increase. Total revenues are expected to climb by between 14% and 20%, reflecting our expectations for comparable store used unit growth, new store openings, a modest increase in used vehicle average selling price, and a continued decline in our new vehicle sales.

Fiscal 2008 Earnings Per Share. We currently anticipate fiscal 2008 earnings per share in the range of $1.03 to $1.14, representing EPS growth in the range of 12% to 24%. We expect modest improvement in both used vehicle and wholesale gross profits per unit in fiscal 2008, as we continue to refine and improve our car-buying processes.

We expect CAF income to increase modestly, but at a pace slower than anticipated sales growth, primarily reflecting the challenging comparison created by the $13.0 million of favorable CAF items reported in fiscal 2007. The CAF gain percentage is anticipated to be slightly above the midpoint of our normalized 3.5% to 4.5% range in fiscal 2008, assuming no significant change in the interest rate environment.

The stock is not cheap but has potential for further growth in a vast market. The price to cash flow and P/E are somewhat high and the growth will be low this year. The ROA and ROE are not very high compared to other established businesses. While the concept clearly holds potential, the bet here is nation wide expansion of KMX over a period of time will increase efficiencies and EPS.

Valueline expects the company to post reduced margins over the next few quarters but do well over the long term as KMX is one of the finest companies in this category. Value line expects double digit bottom line growth for the next three-five years.

Microsoft and Yahoo! Merger

2008-02-10T10:29:00.000-08:00

Microsoft is trying to buy Yahoo! at a price of $31/share. Barrons analyzed this deal and said the price Microsoft is paying is low when compared to the Acquantive acquisition. Henry Blodget, the former internet analyst has this to say about this deal in his blog.

"The first problem with Microsoft's online services division is the name: Microsoft's online services division. MSN, Windows Live, Office Live, MSNBC.com, aQuantive...we'd feel better about the company's chances if it could begin by settling on a brand (or at least a couple of brands).As for last quarter...Online revenue jumped 38% to $863 million, for an overall annual run-rate of a respectable $3.4 billion. Of that, $623 million was advertising ($2.5 billion run rate), making Microsoft's ad business one-seventh of Google's size and about one-third of Yahoo's size.Of the advertising business, which also grew 38% year over year, $112 million came from the aQuantive acquisition. Excluding this, the division's ad revenue grew 24% vs. 25% last quarter. This means Microsoft almost certainly lost more share to Google in the quarter, but may have picked up a small amount against Yahoo.Most importantly, despite the acquisition of profitable aQuantive, Microsoft's online business is still burning money--$800 million a year (after factoring out some non-cash charges). This is an improvement vs. Q207, when it was losing $1 billion a year, but it's still horrible. Even walloped AOL is still printing money. Microsoft's online successes, such as they are, won't be taken seriously until the company is running a large, organically growing, profitable business."

Let us look at the latest numbers from Q2 of 2008. The numbers thus far in 08 is 1.5 billion in revenue with 500 million dollar loss. Yahoo! on the other hand had revenues of ~7 billion with approximate profit of 660 million. Combining the two entities by themselves would result in about 10 billion in revenue with about 340 million in loss. This is without adding any cost saving, talent loss and special incentive packages to retain executives and employees. If one billion is cut from costs it will result in about 600 million in profits. This is not including the increase in cost structure to retain key employees and managers.

This compares to 16 billion in revenues and 4 billion in net income at Google. As can be seen, from the business stand point, Google is ahead and continues to pull ahead as Microhoo! gets bogged down in getting the merger to work.

Retailers - DDS, COST and SHLD

2007-11-23T11:30:00.000-08:00

In the article on retailers, we examined the price/cashflow situation of several retailers. We did miss a few retailers and in this segment, we will look at DDS, COST and SHLD.

DDS - Dillards is a very cheap stock with a price/cash flow of around 4.5. Dillards has been hit by intense competition in the retail sector. With EBIT margin of around 2% and with low ROE, ROA ratios, Dillards main asset is property, plant and equipment. Dillard's equity is more or less the same in the past several years and the property value is most likely understated. A buyout by the likes of Lampert can help unlock the value in this company.

COST - Costco boasts of having Charlie Munger on the board of directors and is indeed a quality company. As is the case with Wesco Financial, costco is not cheap with a price to cash flow of about 15. It has done well compared to other retailers returning about 25% for the year and is overpriced compared to its business fundamentals. There are better bargains out there compared to Costco.

SHLD - SHLD should trade at a premium given that Eddie Lampert is allocating capital for the company. The company generares ample cash to the tune of about 800 million - 1 billion a year and the book value/price is very attractive at current prices. Barron's valued the company at close to $300/share. Even applying a healthy 50% margin of safety to that value will value the company at $150/share.

The current retail environment is offering some great bargains and a prudent investor can make a boatload of money by exploiting the current environment to the maximum.

Lowes vs Home Depot - part 2

2007-11-21T20:19:00.000-08:00

In prior articles, we have looked at home improvement retailers - Lowes and Home Depot respectively. Let us compare the two again, based on most recently ended quarter.

Lowes currently sports a P/E of 11, market cap of 32.6 billion, price/cash flow of 6.91 and is trading close to its 52 week low at 22.11.

Home Depot currently sports a P/E of close to 11, market cap of 55.5 billion, price/cash flow of 8.29. Home Depot has better yield than Lowes at the moment.

In the most recent quarter, home depot's margins declined by 2% points from 11.3% to 9.3%. By comparison, Lowes gross margin declined by 1.42 bais points in the same quarter. Similarly, Lowes sales increased whereas Home Depot's sales declined. ( 3% increase to 3.5% decline )

Home Depot's outstanding shares decliend by 11.4%, helped by the sale of HD Supply. Lowes outstanding shares declined by 3.5% in the same period. Home Depot's book value per share is 9.64$/share where as Lowes is 10.9$/share. Clearly, buying back shares after selling Home Supply unit hasnt added more value to the book for Home Depot as the current share price for HD is around $28 where as it is $22 for Lowes.

Home Depot increased its square footage by 5.5% where as Lowes increased its square footage by 11%. Yahoo! quotes a PEG of 0.69 for Lowes and 0.99 for HD.

Lowes has advantage over HD regarding ROE, ROA and price/cash flow ratios. Lowes seems to be a better alternative to HD from both price and business point of view at this point in time.

Overview of Retail Stocks from Cash Flow Perspective

2007-11-10T18:37:00.001-08:00

In this segment, we will look at the retailers and see which ones offer the best value from the cash flow perspective. The last week has been pretty brutal on retail stocks and it has hurt several retailers in particular. This survey looks at some ( not all ) retailers of interest to the author. The author has positions in some of the retailers noted below.

AEO - American Eagle Outfitters
Price to cashflow is around 9. ( taking out the cash in the balance sheet ) Price to free cash flow this year is 4.8%. Even without increasing cash flow, this company can payout dividends, buy out shares at a better rate than US treasury bonds. The company has zero debt and it is likely that it will grow free cash flow at a decent rate making it a far more interesting buy than the treasury bond over the next five years.

ANF - Abercrombie and Fitch
Also offers a low price to cashflow ratio of about 9 after taking out the cash from the balane sheet. The company carries little debt but the price to free cash flow yield is around 3.8%. The dividend yield in ANF is less than that of AEO.

GPS - Gap
Gap offers price to cashflow ratio of about 9 and a free cash flow yield of about 5.8%. This is significantly better than AEO and treasury bonds. However, Gap's cash flow hasnt altered a whole lot since 1999.

LTD - Limited
Limited's cash flow has also been stagnant for a few years and free cash flow has been somewhat low compared to other peers this year. Analysts are expecting a turn around in the coming years. However, this year, the stock has taken a hit.

CHS - Chico's Fas Inc
Chico's is cheap and the stock price has fallen off dramatically in the last two yearsbecause of declining sales. Still, JOSB and AEO offer better bargains at this moment.

JOSB - Joseph A Bank
Josb offers a very attractive price to cash flow ratio of 6.38. The company does have some debt but price to free cash flow yield is around 9%. Even taking last years figures, it yeilds a figure of about 6%. Looks like a good buy at these prices.

BBY - Best Buy
Best buy also looks interesting at these prices. However, it seems as though best buy is getting serious competition from WMT and friends.

BBBY - Bed Bath and Beyond
This is not as cheap as some of the others in this list. Also, we looked at this in some detail in this blog.

KSS - Kohl's Corporation
Kohl's is a growth story. It cant be compared to the other retailers in the same way.

WMT - Walmart
WMT offers a price to cash flow ratio of 9. The price to free cash flow yield is 2.1%. While this is hardly spectacular, the company spends a huge amount of money on capex in foreign contries.

TGT - Target
Target is somewhat more expensive than Walmart. This is mainly because of the same store sales have been doing better at Target than Walmart.

JCP - J.C Penney
Looks cheap - cheaper than WMT from a cash flow perspective at this moment. The company has spent a lot of money on Capex this year - hopefully this should show in the coming years.

M - Macy's
Macy's had a decline in cash flow and free cash flow this year. This could turn around in the coming years. In that case, this is a turn around play.

LOW - Lowes
Lowes offers price to cash flow of 7.47. It also yields 2.5% on free cash flow. Incidentally, lowes expects to increase both cash flow and free cash flow this year compared to last.

HD - Home Depot
More expensive than Lowes from a cash flow perspective but better from a free cash flow perspective. However, HD's use of capital and growth are both being questioned by share holders.

One can also play the ETF XRT to play the entire sector.

Microsoft Analysis

2007-11-04T17:10:00.000-08:00

Microsoft released its quarterly report recently which beat the analyst estimates. It caused the stock to pop - we look in this section to see if Microsoft has further upside for the next couple of years.

Microsoft is expected to earn 1.81$/share in FY08 and $2.06 in FY09. The uncertainty with the EU has declined significantly after the recent deal. At a low end, Microsoft can trade at $36 - $41.2. At the high end Microsoft can fetch between $40 - $50 at the high end in the next two years.

Let us analyze each of Microsoft's businesses by segment in the latest quarter as reported.

Client: 80 cents of income for $1 of revenue.
Server: 33 cents of income for $1 of revenue.
Online: -39 cents of income for $1 of revenue.
Microsoft Business Division: 65 cents of income from $1 of revenue.
Entertainment and Devices: 8.5 cents of income from $1 of revenue.
Separately, -7.3 cents per dollar is spent on corporate level activity.

This table shows the usefulness of various Microsoft divisions. Windows client is by far the most profitable group followed by Microsoft Business Division. This is followed by Server and Tools. Entertainment and Devices and Online are losing money/marginally profitable as is corporate level activity.

Microsoft's strength is its windows (client,server) and office franchises. These businesses should continue to drive Microsoft for the next five-ten years. As the spending in corporate level activity shows, there is room for improvement in capital allocation. One can also expect stock buy backs to offset further stock dilution. On a positive note, the company is returning capital to the investors in the form of dividends which will allow the shareholders to deploy it in a more meaningful fashion.

However, for the next two years, the downturn in housing and financial sectors would continue to propel technology stocks. This should help Microsoft attain further peaks in its stock price.

Berkshire Hathaway Q3 Analysis

2007-11-04T14:03:00.000-08:00

In this blog, we have analyzed Berkshire quarterly reports for quite some time. We will take a look at Berkshire Q3 earnings and take a look at few areas.

Morningstar had the following summary for Berkshire after Q3 in the article titled "Berkshire Puts Some Capital to Work"

On the investment side, it appears Berkshire put roughly $11 billion of its cash hoard to work in equity securities this year. This isn't overly surprising given the tumult in the markets, and chairman Warren Buffett's excellent track record of deftly deploying capital in times of financial stress. In spite of this, though, Berkshire still has more than $40 billion of cash on its balance sheet. While we recognize that roughly $10 billion is required for insurance regulatory purposes, Berkshire still has about $30 billion available for additional investment. We suspect that over time, this will be deployed into business acquisitions or situations requiring an injection of liquidity.

Since this article does an adequate job of summarizing the quarter for Berkshire, we will look at the areas this report doesnt cover.

The book value grew by 3.98% from Q2 to Q3 and by 10.9% for the first nine months of the year. So the stock is clearly on its way to better SP500 in book value growth for the year. Having beaten SP500 in four of the past six years in book value growth alone, (business value growth is greater ) looks like this is another year where Berkshire is going to out perform SP500.

The other metric to look at is operating cash flow. Last year, this came in at 10.195 billion dollars. This year in the first three quarters, this is at 11.351 billion dollars. The run rate is about 40% higher than last year. This excludes gains from investments which is a huge part of Berkshire's cash flow.

Despite investing heavily in equities in the quarter ( and the year ), the gushing cash flow continued to add to the liquidity of the balance sheet.

The intrinsic value of BRK A share is now in the 147 - 152K range when conservatively valued in my opinion. This should grow to 153-158K range by end of this year.

RDN Analysis

2007-11-04T07:22:00.000-08:00

Radian operates in the following businesses:

Mortgage insurance business provides credit protection for mortgage lenders and other financial services companies on residential mortgage assets through traditional mortgage insurance as well as other mortgage-backed structured products.

Financial guaranty business insures and reinsures credit-based risks and provides synthetic credit protection on various asset classes through credit default swaps.

Financial services business consists mainly of our ownership interests in Credit-Based Asset Servicing and Securitization LLC (“C-BASS”)—a mortgage investment and servicing firm specializing in credit-sensitive, residential mortgage assets and residential mortgage-backed securities—and in Sherman Financial Services Group LLC (“Sherman”)—a consumer asset and servicing firm specializing in credit card and bankruptcy-plan consumer assets.

In 2006, MI provided 49% of revenue, Financial Guarantee 23% and Financial Services 28% of revenue respectively.

Following the collapse of the subprime market and the scandal with rating subprime debt a lot of the banks and insurers have taken a huge hit to their balance sheets. In this analysis, we look to see if Radian has a future and is an investment at these prices.

In the quarter ending June 30th, each of the above segments contributed to income as follows:
Mortgage Insurance: -28.2 million
Financial Guarantee: 22 million
Financial Services: 27.3 million

The company reported a profit overall despite a negative mortgage insurance segment.

Interestingly enough, MTG also reported a profit in this quarter. But MTG reported a loss in Q3 and issued the following guidance regarding FY08.
MTG is providing the following guidance for the remainder of 2007 and the full year 2008:

•2007 Fourth Quarter paid losses approximating $270 to $290 million
• 2008 paid losses approximating $1.2 to $1.5 billion

This is the worst case loss of 1.8 billion with a shareholders equity of 4 billion for MTG.

Let us now look at Radian Q3. In the business call on 9/5/07, management offered the following scenarios for book value from 2007 through 2010. Book value of $46.9 in 07, $49 in 08, $54 in 09 and $59 in 10.

The Q3 book value came in less than what management predicted at $42.86.

From Q3 onwards, the company will only have two lines of business, mortgage insurance and financial services. In both these sectors, the company took a loss by valuing the derivatives to the mark to market criteria. Excluding this, the loss in the MI division was about 200 million. Financial Services had a slight profit. The company booked a large loss in Q3 and wrote off all of CBass investment. The company also thinks it can pay off the mortgage liability from the reserves and has adequate capitalization.

The stock holder equity was 2.2 billion in the MI division and 1.3 billion in financial services division.

Now let us look at two scenarios. The first one is the normal case as outlined by the company. This involves about 10% loss in the bubble states such as California and Texas. This is also the worst case envisioned by some other independent groups as well. The stress case involves taking 20% loss in these states and the company should do fine in this case. The reduction in book value in Q3 came in as management had expected except for the mark to market of derivatives. In the worst case, one can expect the book value to go to $30 in this scenario.

In the second scenario, we can expect the losses to continue till end of 2008 and mid 2009 at the current rate and another write off of 1 billion from the book value. This should still leave 2.1 billion in book value about 3 times the current market price for the stock. Even writing off the entire mortgage insurance business off still leaves a value of around ~$19/share in Radian.

The great risk for the company is downgrading of its credit from AA to a lower grade by SP and Moody's. In this case, the business may be harmed beyond repair. In the conference call, management was confident that it will be able to maintain its rating.

This stock has high uncertainty and low risk built in. A patient investor may be rewarded handsomely for holding on to this asset.

Four pillars of Tech

2007-10-18T19:41:00.001-07:00

The four pillars of tech according to Kramer are:

1. RIMM
2. AMZN
3. GOOG and
4. AAPL

Let us look at each of these to see if they offer good bargains at current prices.

1. RIMM carries a P/E of 76, PEG of 1.56, Price to cash flow of 90.

2. AMZN carries a P/E of 124, PEG of 3.54 and price to cash flow of 42.

3. GOOG carries a P/E of 50, PEG of 1.22 and price to cash flow of 46.

4. AAPL carries a P/E 49, PEG of 2 and price to cash flow of 32.

AAPL is the cheapest from the P/E and P/CF point of view. Google is the cheapest by PEG point of view.

From a discounted cash flow point of view, none of the stocks look cheap and each of them look quite expensive. In the long term, the value is likely to catch up with price - this can happen through stagnant or declining share price.

HOG (Harley Davidson) Analysis

2007-10-06T08:57:00.000-07:00

Harley Davidson (HOG) is the iconic American motor cycle manufacturer. It is more than a brand in many ways - many people tattoo HOG on their bodies. It is difficult to find many companies that people are willing to tattoo on their bodies. Of late, HOG stock price has declined because of stagnant or slightly declining year over year sales. Let us analyze the stock in further detail in the rest of this blog. HOG embodies a lifestyle and in some sense beyond a brand.

HOG has a P/E of ~12 and price to cash flow of about 13. Price to book value is about 4. The dividend yield for the stock is about 2%. While the stock is undoubtedly cheap as it is very difficult to replicate the Harley brand for the market cap of the company which is about 13 billion. While the intangibles add significantly to Harley's book value, let us see if the company is a buy at the current prices.

First let us analyze Harley. The number of outstanding shares has been declining by about 1.6% per year for the last ten years. The EPS has grown by about 20% per year for the past ten years - which is clearly not sustainable.

Let us look at the cash flows and return on equity to see how HOG looks like from this perspective. The cash flow from operations for the last five years have been respectively - 936, 970, 960, 762 and 998 million dollars respectively. The free cash flow has varied from 708 million to 782 million respectively. The return on equity has varied from 29% to 39% of late.

The company's YoY sales in the US has declined by about 5% and the company is hoping to expand internationally further. Like other consumer staples such as Coke and Pepsi, HOG will probably see more revenue and profits internationally in the future.

The stock looks cheap compared to its historic P/E of about 19. Even given the stagnant cash flows, the company is returning money to the share holders in the form of dividends and share buy backs. HOG is a good long term buy but may not see immediate upside.

Proctor and Gamble Analysis

2007-09-30T18:10:00.000-07:00

PG ( Proctor and Gamble ) is in the consumer staples business. It was the best performing dow jones stocks for the recently ended quarter. Let us quickly take a look at the financials to see if it is a buy at current prices. With a P/E of 23 and Price/Cash flow of close to 18, the stock doesnt appear cheap at current prices. Let us take a deeper look at the numbers to see how things look like.

The company bought Gillette recently, which has helped its cashflow and net margins. The EPS has grown at the rate of 9% a year for the past ten years and is likely to grow at that rate in the future.

The business is doing well on all fronts as noted in the company's 10-Q:

Net sales fiscal year to date increased 14 percent to $57.20 billion behind 11 percent volume growth, including an additional three months of Gillette results during the current fiscal year to date period versus the comparable year ago period. Organic volume grew five percent with broad-based growth across the business. Every reportable segment delivered year-on-year organic volume growth driven by product initiatives including Tide Simple Pleasures, Febreze Noticeables, Pantene Color Expressions, Olay Regenerist and Definity and the Head & Shoulders and Herbal Essences restages. Price increases taken across several segments added one percent to sales growth while favorable foreign exchange trends had a positive two percent impact. Product mix had no net impact on sales growth as the favorable mix impact from the additional period of Gillette results was offset by disproportionate growth in developing regions, where unit selling prices are below the Company average. Organic sales increased six percent fiscal year to date.

Additionally, the per share growth has been impressive partly because of the accretive nature of Gillette's business.

Net earnings increased 19 percent to $8.07 billion behind organic sales growth, the impacts from the addition of Gillette, including financing and other acquisition-related expenses, and profit margin expansion. Diluted net earnings per share were $2.37, up 13 percent versus the prior year. Earnings per share growth lagged net earnings growth due to a net increase in the weighted average shares outstanding in the current year to date period (incremental shares issued in conjunction with the Gillette acquisition on October 1, 2005, net of share repurchases, primarily under the Gillette repurchase program).

The fastest growing business segment was health care products. The gillette razors and blade segment is growing impressively in the developing countries.

Overall, PG is a great business. The current price levels are a bit too high - the right time to buy this was during the summer months during the peak of the credit crisis.

Bed Bath and Beyond (BBBY) Analysis

2007-09-08T05:11:00.000-07:00

In this blog, we have looked at retailers such as Walmart, American Eagle and Joseph A Bank. Let us analyze another specialty retailer, BBBY and see if it is a good investment opportunity at this time.

BBBY is a retailer specializing in bedding, bath and kitchen products. It also sells electronics, electrical equipment ( kitchen electrics ), furniture, wall and home decor. It targets the rich to upper middle class customer and competes with a slew of other retailers in this space. Its closest competitors are Target ( which targets the middle class customer ) and Linen and Things. In each of the segments it operates in, there are a slew of speciality retailers that compete for the same business.

Let us look at the latest 10-Q report and past reports to see how BBBY stacks up against some of the other retailers. In the most recent quarter, BBBY saw increase of sales (~11%) through store expansion and through the acquisition of buy buy BABY. Meanwhile, the gross profit margin declined because of rising inventory costs and selling, general and administrative cost went up. The result was a decline in operating profit margins to 9.9% from 10.7% from the same period a year ago. Does the declining profit margins show a fiercer competitive environment? Let us look at the profit margins for the past five years to figure this out.

The operating income for the past five years are as shown below with a compound annual growth rate of 7%.

639.3
792.4
879.2
889.4
895.0 (expected for this year )

The operating margin has declined sharply this year and last compared to the previous two years to the 2003 levels. This is a bit early to say if this is because of fiercer competition. The reduction in margins could also be because of the decline in the housing market. However, this should have been more pronounced in 2007 as opposed to 2006 which is not the case.

The company has decided to buy back about a billion dollar worth of shares in December 2006 and the total number of outstanding shares has declined in the most recent quarter by about 7 million compared to the same period a year ago. The company has about 20 million shares outstanding (options) and about 6 million shares in restricted stock. While many of the options are under water at the moment, the addition of close to 9% of additional shares can dilute the impact of buy back.

On a positive note, the company carries no debt and is funding its expansion through operating cash flow.

From a cash flow perspective, there are cheaper alternatives such as Walmart and Target and a slew of other retailers noted earlier in this blog such as AEO and JOSB.

While the company is healthy, the impact of housing slow down and competitive pressures is not fully clear at the moment. It is our view that there are other retailers that offer a better discount to intrinsic value than BBBY.

Infosys Q1 Analysis

2007-09-03T17:18:00.000-07:00

In this blog, we have looked at Indian outsourcer, Infosys quite a few times. We found Infosys to be the best run of the Indian outsourcers with solid management. In the first six months of the year, the Indian currency appreciated by about 10% against the US dollar. This appreciation was partly precipitated by the Indian central bank keen to cut inflationary pressures. The exchange rate of the Indian currency is artificially maintained as the currency is not freely traded. This is similar to the way the Chinese government maintains its peg against the US dollar.

The problem for Indian companies that are exported focussed is that it increases their cost of operations. While some of the cost can be passed on to the customers, it will not be possible to pass on all the costs to the customers. In addition, Infosys and other Indian companies are facing increase in operating costs with wages increasing at double digit rates of 15%. This impact is probably not fully felt yet and show up further in the coming year. The wage increase is expected to be about 15% in the coming year as well.

The operating income margin in Q1 of 2006 for Infosys was 25.75%. The operating margin in Q1 of 2007 was 24.67%. In general, the business did well, with revenues and profits growing strongly. As usual, the stock market looks at future prospects as opposed to past results. Infosys is expected to continue to do well with growth in the 28-31% range for FY2008.

Other points of note is attrition rate of 4% in the quarter and 10% new employees in Q1 alone. Infosys expects to pay new employees higher wages compared to the ones hired before. Infosys now employs about 75000 people world wide. The increase in cost will increasingly be felt in the next couple of years which is reflected in the stock price.

The company has a strong balance sheet with about $1.6 billion in cash. The company is run well and this is reflected in the stock price. However, we feel that the company is fairly valued at current price levels.

Value vs Growth

2007-08-26T19:21:00.000-07:00

We are looking at this again after a short gap. Given the disaster in the financial sector and the dominance of financials in the value fund, the value fund hasnt done too badly.

The chart below shows how value, blend (sp500) and growth compare in the large cap arena. The chart below shows the iShares ETFs - IVE, IVV and IVW.
The top stocks in IVE (value etf) are:
AT&T,
GE,
Citigroup,
BAC,
JP Morgan Chase,
Conoco Phillips

The top five stocks in IVW ( growth ETF) are:
Exxon Mobil,
Proctor and Gamble,
Cisco Systems,
Johnson and Johnson and
AIG

The difference between value and growth is not wide with iShares ETFs.

http://finance.yahoo.com/q/bc?t=6m&s=IVE&l=on&z=m&q=l&c=ivv%2Civw

The second chart compares the vanguard funds in the same category. The vanguard funds of interest are VTV, VV and VUG respectively. The mix of stocks in vanguard funds is different than the iShares funds - so the difference in performance is also different. As an example, Berkshire is in vanguard growth fund but not in the value fund. Comparing to iShares ETFs, the stocks and their weights are also different.

The top holdings in VUG are:

Microsoft,
Proctor and Gamble
Johnson and Johnson
Cisco
Intel

The top holdings in VTV are:

Exxon Mobil,
GE,
A&T,
Citigroup and
Bank of America

http://finance.yahoo.com/q/bc?t=6m&s=VTV&l=on&z=m&q=l&c=vv%2Cvug

While the companies in both the lists are good, citigroup and BAC may have to take some charges on the buy out transactions still pending for which commitments are made. While this is a good time to buy - it may be in the doldrums for some time.

The differentiation of stocks to value and growth is quite arbitrary and one should do ones due diligence before selecting one sector over the other. It also depends on which funds one selects and what cost advantages an ETF or a bunch of ETFs provide over the other.

Jos A. Bank Clothiers (JOSB) revisited

2007-08-18T07:07:00.000-07:00

Now that all the retailers are in a funk thanks to the subprime mess as well as the Walmart warning, let us look at this section again.

We have looked at JOSB before in this blog and noted that P/E contraction was a major risk to both JOSB and Chico FAS. True enough, even though the sales have done well, people have been dumping JOSB as well as other retailers enmasse creating an opportunity.

Let us look at JOSB business and macro factors first. Jos. A. Bank Clothiers, Inc. is a nationwide retailer of classic men’s clothing through conventional retail stores and catalog and Internet direct marketing. What are the factors that can go right and what are the factors that can go wrong for JOSB?

Things going right:
1. Good job market - always a plus for JOSB. It is unlikely this will falter given the strong growth in emerging markets, europe and Japan. The U.S export growth continues to grow and the dollar will probably decline further if there is a rate cut. This bodes well for JOSB.

This not going well:
1. The housing market. A bunch of ARMs are scheduled to be reset next year - this can cause problems to JOSB and other retails if it impacts the US consumer abnormally.

If the job growth continues and the ARM resets occur in an orderly way - the consumer mix for JOSB is going to determine how well it will do.

For this, let us look at the financial statements.

First cash flows - JOSB has a price to cash flow ratio 0f 7. What this means is that the business can pay out the entire capital back in seven years if nothing is reinvested in the business. However, a part of the capital will have to be reinvested to keep the business going. Another part to look at is the sustainability of the cash flow. Let us look at the balance sheets to gain further insight into these factors.

First let us look at the free cash flow growth. It has been far for uniform - in fiscal 2002 and 2004, the company had negative cash flows. The company is excpected to have free cash flows of ~40 million this fiscal year. So the cash flows are not even meaning some dependency on the economic cycles are present.

Let us look at the latest 10-Q for more details. The company is planning to add more stores this year to expand the number of stores from 366 to close to 500. The company would put the store expansion plans on hold if there is a chance to lose money on the investment or if it is very risky. As noted by other retailers, the sales havent fallen off the cliff yet but people are expecting catastrophe to hit when the ARMs reset.

JOSB looks attractive at this price, with book value of approximately $12/share - it is definitely selling below its intrinsic value and can offer some good upside if the ARM reset doesnt hobble the economy badly. Note: please see the disclaimer part of this blog.

Berkshire Hathaway FY07 2nd quarter results

2007-08-04T07:55:00.000-07:00

Berkshire Hathaway, the holding company run by Warren Buffett, reported its 2nd quarter earnings yesterday. In this blog, we will go through the earning report and look at the earnings and the company.

The company had 1,088,878 class A shares and 13,753,590 class B shares for a market cap of approximately 169 billion dollars. Total shareholder equity was 115.27 billion dollars. So the price to equity ratio is less than 1.5. This is a low number for a company that grew the operating earnings and total earnings in the low 20s and 30 percentage respectively showing that the stock is quite undervalued.

There are a few things of note to observe in the consolidated statement of earnings. Let us look each segment and compare it to the perception of analysts and market commentators.

In the insurance and other segment, sales and service revenues increased as well as investment gains. Geico increased its market share managing to increase profits in an environment of falling insurance premiums. General Re and BRK Reinsurance did particularly well. General Re is doing well overall and should continue to do well for the rest of the year. BRK Reinsurance is doing well in the multiline business segment but megacat insurance premiums will decline in the next year. This should be offset to a certain extent by investment gains on the equitas portfolio.

Utility and Energy section saw revenue and earning growth. This section is doing well as expected.

In the finance and financial products section, interest income slightly increased, investment gains declined compared to the year ago period, derivative gains increased and the other section was flat.

The important thing to point out here is that the interest income from treasuries is not significantly higher than last year as many analysts were expecting. In the first six months of the year, 3.3 billion of fixed maturity securities were bought and another 11.5 billion of equity securities were bought. The important thing to note here is that the securities delivered as part of the equitas deal is listed separately in the cash flow statement. The cash and cash equivalents stood around 39.9 billion. This figure is different in the cash flow statement as some of the money is borrowed for mid american subsidiary.

Interestingly enough, the break down of fixed maturity securities showed 3.7 billion of mortgage backed securities. This number should increase in the coming months as the market remains illiquid and the yield spread widens.

As an intelligent investor may recognize, this is Buffett and Munger time. Irrational fear and illiquid markets plays perfectly into the hands of worlds great investors. In addition, many of Berkshires core holdings like P&G, Walmart, HD etc. dont have liquidity problem and are buying back stock. This should help increase the book value and networth of Berkshire in the coming years.

My breakdown of intrinsic value is around 142 - 145 K per A share after Q2. In fact, the stock deserves a premium for the opportunities available at the moment. One should have part of ones portfolio in this stock as it allows for capital preservation and appreciation at the same time.

Four pillars of Tech

2007-07-15T21:40:00.000-07:00

Kramer classifies these four companies as the four pillars of tech. According to him these are the standard bearers for the first decade of the 21st century. It is anyone's guess if their dominance will last till the next decade - most likely it wont if we look at tech wonders from the nineties - Intel, Microsoft, Cisco, Dell and Yahoo!

Here are the four companies:
RIMM - blackberry a must for corp execs.
AAPL - iphone and ipod. iphone is getting to be a competitor to blackberry in the longer term.
GOOG - 'nugh said. Goog is planning a free google cell phone with its own apps. Going against apple? May be.
AMZN - virtual warehouse, S3 and EC2 services.

AMZN - market cap of 30 billion and free cash flow of 500 million - ratio 60
GOOG - market cap of 172 billion and free cash flow of 1.8 billion - ratio 95
AAPL - market cap of 120 billion and free cash flow of 3.9 billion - ratio 31
RIMM - market cap of 40 billion and free cash flow of 480 million - ratio 83

Let us take another swap by looking at stock dilution at each of the companies.

AMZN - has remained flat in the last few years probably because of buy backs.
GOOG -should be 6-7% range or higher
AAPL - about 2.5% dilution per year
RIMM - no dilution in last year - most likely because of buy backs.

Berkshire (BRKA/BRKB) on the other hand throws off cash better than most companies in America. Its price to cash flow ratio is less than ten making it a bargain compared to any of these tech stalwarts. Moreover, the stable of businesses that are part of Berkshire are likely to remain solid and kicking long after today's tech titans make way for another round of upstarts in the next decade.

A case for power

2007-07-14T09:50:00.000-07:00

PWER - better known as PowerOne is a California based company that specializes in building AC and DC power conversion systems. The stock has seen a high of about 100 during 2000 and has fallen to about 4 at the current time. The implosion in the market caused by dot.com bust played a big part in this plunge.

The company has not been run properly for the larger part either. The company's acquisitions havent really panned out atleast not yet. This caused a sudden plunge in company's stock price from $5.5 to $3.5. Although the stock has recovered somewhat, the stock hasnt recovered fully yet.

However, there are signs that the company is finally on track to recovery. Several factors should help the company.

1. The power market is on the rebound with imprving semiconductor business.
2. The server farms in the US are expanding, so much so that the total power consumed by server farms outstrip the power consumed by all TVs in US homes. Minimizing such power usage is critical is containing operational expenditure of running large data centers.

The company believes it will be profitable in the final quarter of 2007. If so, it would be first such event in the past several years. Sustained profitability can boost the company stock significantly above the current levels.

Even if the company is not profitable, I estimate the lower end of the price to be about $5 for the company's assets. A lot is riding on current earning announcement and a prediction to return to profitability can turbo charge the stock. Another lackluster announcement can present a significant buying opportunity.

Also on a positive note, insiders have been buying at $3.69 levels though in small quantities.

P.S: Please be sure to check the disclaimer of this blog.

Berkshire possible return on investment

2007-06-24T12:10:00.000-07:00

Mohnish Pabrai, the author of the book "Dhandho Investor" and a hedge fund manager, recently interviewed with Bloomberg. The pointers to his interviews are noted below:

Part 1 http://wpi.clipsyndicate.com/publish/index/339725

Part 2 http://wpi.clipsyndicate.com/publish/index/339737

In Part 2 of this interview, he values BRKB at around $5000/share and expects 15% return for the next several years. Let us calibrate this with other forecasts and see if this is a good prediction.

For starters, let us assume that the current valuation of BRKB is indeed $5000=00. Currently, the stock is trading at 3578=00. This makes the stock about 40% undervalued compared to its market value. Even without additions to the intrinsic value for the next three-five years the returns would be as follows:
1. 3 years - 11.7%
2. 5 years - 6.9%.

This is the typical - heads I win, tails I dont lose position.

Let us take the second situation where the intrinsic value is a lower value of 4700 per share. Let us assume that Berkshire will be able to grow the intrinsic value at 8% per year for the next three-five years. For a three year period, the IV will be 5920/B share. For a period of five years, the IV will be 6905/B share.

If the per share value catches up with intrinsic value - the growth per share will be.

1. 3 years - 16.7%
2. 5 years - 14%.

Let us take another situation where the intrnsic value grows from the current value of 3578=00. The EPS growth will atleast be 8% a year as SP500 will continue to grow at around 7-8% for the next three years. The Berkshire equity portfolio will do as well or better. Then there is the cash generated by operating businesses which is growing at >20% a year. This should continue at a rapid 15-20% pace for the next five years. At the very minimum, one should continue to see 8% a year growth without doing anything with the existing cash horde.

This is a classic situation of "heads I win, tails I dont lose much". The upside is decent and downside is very low to non existent.

Microsoft DCF Analysis

2007-06-17T21:00:00.000-07:00

Here are the estimates of Microsoft free cash flow on a year by year basis.

Free cash flow per year:
2007 - 14.5 billion
2008 - 16 billion (estimate )
2009 - 16 billion ( estimate )
2010 - 17.5 billion ( estimate )
2011 - 19 billion ( estimate )
Terminal market cap - 366 billion

Discounted at 10% per year to now:

2007 - 14.5 billion
2008 - 14.55 billion
2009 - 13.22 billion
2010 - 13.15 billion
2011 - 12.98 billion

Terminal market cap - 250 billion

Summing up: The present value is 318 billion.The current market value is 290 billion. The upside is about 10% from current values.

The downside and caveat to this estimate are as follows:

1. Stock dilution because of heavy payments to management and employees
2. The cost of competing with Google. This could be a drain on the cash flow with XBox and other emerging businesses continuing to be a drain on cash.

If Microsoft is able to meet the EPS estimate of $1.70/share in FY2008, the share price can presumably trade in the $33-35 range. Microsoft has seen a P/E compression in the past few years as its earning growth has slowed down. The above share price range is with the current P/E. Further P/E compression to the mid teens can make the stock price stagnate at current levels.

American Eagle (AEO) - Ready to soar again?

2007-06-09T17:13:00.000-07:00

In the recent months, the US retail sector has taken a big beating with many stocks trading in the value category. In this section, we will take a look at American Eagle ( AEO ) Outfitters and see the prospects.

First some basics on American Eagle. American Eagle Outfitters, Inc., a retailing company, engages in the design, marketing, and sale of clothing in the United States and Canada.The comapny has been growing fast with 20%+ growth in the past several years. The company's growth has slowed in this year to ~17% rate. The company also hasnt met the analyst's expectation of 5.8% growth in same store sales in the month of May. The company's sales came in at 5% instead. This coupled with the expectation of a recession/high interest rates has caused almost all the retail stocks in the US to become bargains. The list includes companies such as JCP, WMT, ANF and JOSB.

AEO is particularly attractive compared to this group as it carries zero debt on its balance sheet and its growth rate is still in the double digits. The company has about half a billion dollars of cash on the balance sheet and is buying back about 15 million shares. This should reduce the number of outstanding shares by 7-8% and boost the EPS by 7.5 - 8.5%.

Let us do the discounted cash flow analysis for AEO for the next five years. In the fiscal year ending in Feb, 2007, the company had cash flows from operating activities of 750 million and a free cash flow of 525 million. The company has a current market cap 5.75 billion. Assuming conservative growth rates of 15%, 12%, 10%, 8% and 6% for the next five years and a terminal value of 10 billion for the enterprise.

Adding the DCFs, the value looks as follows with a discount rate of 10%.

525 million
548 million
558 million
548 million
528 million
terminal value 6.2 billion

This yields a value of 8.9 billion for the enterprise without even considering share buy backs. This is a premium of 56% from the current prices for this stock.

To quote Mohnish Pabrai - this looks like a classic situation of "Heads I win, tails I dont lose much!". While the entire sector is battered, AEO seems like an opportunity that is hard to pass up.

Value or Growth?

2007-06-09T16:51:00.000-07:00

We have looked at this aspect in some detail in this blog when we assessed different asset classes in the past several months. In this article, we look at the market behavior from last week and compare value vs growth again.

The difference in returns from the three Vanguard funds are noted below for the past one week.

Comparison of VUG, VV and VTV

Typically, increasing interest rates causes the dividend yielding stocks to be less attractive. The stocks with high growth are better preferred. Since the value stocks have a fair degree of exposure to dividend paying stocks, for the week, the VTV lagged VUG by a small margin.

This is a trend I will be watching closely in this blog in the next several months.

The value funds have done well for the past few years on the back of high energy prices and the housing boom. A difference of one or one and a half percentage points between the two funds is made up by the value fund in terms of dividends.

However, the pattern may be changing with money flowing into the tech sector. So far, we have seen only a handful of tech companies benefit by this trend - Google, Apple and Amazon are the ones that come to mind. Since these stocks are already in the stratosphere in terms of valuation, the rally hasnt been very broad.

Overall the U.S and global economy seems to be in good shape and corporate earnings should continue to do well in the second half of the year. This bodes well for SP500 average in general and the broader stock market in particular.

Asian ETF overview

2007-05-28T19:41:00.000-07:00

Happy memorial day to all the US based readers. Seekingalpha has an excellent overview of Asian ETFs and their performance to date compared to SP500 index tracking fund IVV.

http://etf.seekingalpha.com/article/36655?source=feed

Whitney Tilson on Learning from Investment Mistakes

2007-05-25T18:03:00.000-07:00

Another gem from financial times - http://search.ft.com/ftArticle?queryText=tilson&aje=true&id=070216005308

Whitney Tilson: Learn from your own investment mistakes
By Whitney Tilson, FT.com sitePublished: Feb 16, 2007
Investing is a game of averages: nobody bats 1,000 but, if your analysis and judgment are solid and your winners generally go up more than your losers go down, you can build an outstanding record. The key is not picking big winners; it is avoiding big losers.
That's why learning from mistakes is so important – ideally, as Warren Buffett says, others' mistakes rather than your own. In that spirit, here are 10 traps I've identified – many times the hard way – that are likely to lead to bad investment outcomes:
■Declining cash cows. There can be a fine line between opportunity and trouble when a once-strong business goes into permanent decline. One can profit if the market overestimates the speed of the decline or underestimates management's ability to transform the business. But this is a hard way to make money. Generally speaking, a business in decline – even a cash cow business – is a painful, drawn-out affair. Investors in newspaper stocks in recent years have seen this first-hand.
■High and rising debt. Value investors are naturally drawn to companies in trouble – that's what makes stocks cheap if the difficulties prove to be temporary – but beware of high and rising debt levels. Even if a company is positioned to benefit from improving conditions over time, equity holders won't benefit if its debt levels trigger a bankruptcy or a massively dilutive refinancing in the near term.
■Unions and legacy liabilities. When betting on a turnround, it's critical to understand the flexibility the company has – or doesn't have – in implementing painful but necessary changes. Poor union relations can prevent such changes, and legacy healthcare, pension and environmental liabilities can serve as the same drag on a company's prospects as too-high debt. ■Weak or erratic cash flow. Operating cash flow, because it adds back depreciation and amortisation to net income, should be higher than reported profits. If it's not, figure out why. Are there unusual items consuming cash? Are inventories or accounts receivable ballooning? In the 11 quarters ending in the second quarter of 2000, Lucent reported pro-forma profits totalling $9.4bn. Over the same period, it had a free cash flow deficit of $7bn. This should have been a tip-off for investors, who suffered as the stock plunged from more than $70 to less than $1.
■Over-reliance on one customer. In my experience, one of two things happen to companies that derive a large portion of sales from a single customer: at some point, the company loses the customer or the customer renegotiates the deal – either of which is devastating to the company and its stock.
■Consumer fads. Famed short-seller James Chanos put it well in a Value Investor Insight interview explaining why fad-driven companies often become great short ideas: "Investors – typically retail investors – use recent experience to extrapolate ad infinitum into the future what is clearly a one-time growth ramp of a product. People are consistently way too optimistic and underestimate just how competitive the US economy is in these types of things."
■Deeply cyclical industries. Fortunes can be made by investing in cyclical businesses if you have a deep understanding of the industry and you're buying at maximum pessimism. If neither is the case, discretion is often the better part of valour. Just ask those attracted to the ostensibly low multiples of subprime mortgage lenders before last week's revelations of deteriorating loan-portfolio credit quality.
■Focus on earnings before interest, taxes, depreciation and amortisation (ebitda). Used properly by those who understand its limitations, ebitda can be a useful measure. But too often it's used by unscrupulous management, investment bankers or analysts to make a stock appear cheap – a stock's ebitda multiple is always lower than its p/e multiple – or to deceive investors about the true nature of a company's capital requirements. It's not a coincidence that many big frauds, such as WorldCom, weretouted using ebitda metrics.
■Serial acquirers or mega-acquisitions. Given the research showing that two-thirds of all acquisitions are failures and a wide range of accounting shenanigans that can occur when one company acquires another, it's remarkable how often investors get excited about big acquisitions or roll-up stories. While my funds own Tyco today as a discount-to-the-sum-of-the-parts story as it sheds its conglomerate structure, we fortunately avoided it when it was a serial acquirer.
■Aggressive accounting. Grey areas in US Generally Accepted Accounting Principles (GAAP) leave management with tremendous leeway in how aggressively or conservatively it represents company operations. I have difficulty thinking of a single instance in my entire career of a company that blew up in which there were not signs of aggressive accounting.
Mistakes are inevitable but every savvy investor should at least try to make original ones. Recall the proverb: "Fool me once, shame on you. Fool me twice, shame on me."
Whitney Tilson is a money manager who co-edits Value Investor Insight and co-founded the Value Investing Congress. feedback@tilsonfunds.com

Whitney Tilson on steps for value hunters

2007-05-24T21:27:00.000-07:00

From http://www.ft.com/cms/s/cfa86a18-0559-11dc-b151-000b5df10621.html

Whitney Tilson: Not-to-be-missed tips for value hunters
By Whitney Tilson
Published: May 18 2007 18:25 Last updated: May 18 2007 18:25
My recent column detailing the 10 investment traps I’ve identified prompted several readers to ask if I have a comparable list of the opposite – types of opportunities that are likely to lead to good investment outcomes.
I do, and happily it’s a bit longer than the list of traps. Given that the first step to successful investing is knowing which ponds to fish in, here are the 15 most common types of value opportunities I have been able to capitalise on in my investing career:
● Out-of-favour blue chips. Even the greatest companies encounter problems or otherwise fall out of favour. We bought McDonald’s a few years ago when it fell below $13, believing in its assets and that it could return to its former glory through better management. The shares now trade above $50.
● Turnrounds of broken businesses. It’s difficult to fix a truly broken business, but when it happens, the returns can be extraordinary. One of my best investments ever was CKE Restaurants, which engineered a spectacular turnround at Hardee’s due to its new Thickburger menu. The shares, as low as $3 in 2003, are now above $20.
● Cyclicals at the bottom of the cycle. Success here usually involves correctly anticipating when a cyclical industry will rebound, though precision is not necessary as long as the company has a strong enough balance sheet to weather the tough times.
● Distressed industries. Our buying auto-systems maker Lear last year below $20 when its prospects were considered most bleak is a successful example of buying a good company in a distressed industry. Its shares have more than doubled off their lows.
● Overlooked small-caps. Among the 5,000 or so publicly traded US stocks that have no analyst coverage are fine businesses that are cheap because no one is paying attention to them or the stocks are thinly traded. A good example we’ve owned for years is Weyco Group, which makes Florsheim shoes.
● Fallen growth angels. When high-growth companies slow down, growth and momentum junkies often sell indiscriminately, which can create great opportunities for value investors. Just be careful not to anchor on the stock’s previous price or earnings multiple, which are no longer relevant.
● Growth at a reasonable price. These are also high-quality growth businesses, but the stocks haven’t fallen. They may not appear cheap on traditional valuation metrics, but can be excellent investments if the high growth can be maintained. Starbucks over the years has been a great example.
● Piggybacking on activism. There are select opportunities to invest alongside experienced activist investors pushing for prudent change. One of our most profitable investments over the past two years, for example, was following Pershing Square and Trian Group into Wendy’s International, which has more than doubled.
● Spin-offs. Many significant stock-price inefficiencies can occur when a company is spun off. A recent example we currently own is Mueller Water, which operates largely under Wall Street’s radar and is uniquely positioned to benefit from needed investment in US water-system infrastructure.
● Post-bankruptcies. There are also many reasons why companies emerging from bankruptcy can be inefficiently priced, not the least of which is investors’ reticence to back a recent loser. We’ve almost tripled our money in less than two years owning shoe retailer Footstar, which came out of bankruptcy with a solid balance sheet and plan for reviving itself.
● Let someone else do the investing. Certain public companies, including Berkshire Hathaway (which we own), Loews, Leucadia National, Alleghany and White Mountains Insurance are structured as investment vehicles for proven value investors. At a reasonable price, it can pay to let these investors do the heavy lifting for you.
● Free/mispriced option. In these situations, one or more ongoing businesses justifies the current market price and an investor gets a valuable option – in the form of a new market opportunity or turnround of a floundering business – for almost nothing. In Wendy’s, we thought the value of its Tim Hortons restaurant franchise was worth the entire stock price two years ago, so we were getting the Wendy’s brand restaurant and franchising business for free.
● Declining cash cow. At the right price – and if management wisely milks the business and allocates capital – the stock of a declining business can be a great investment. The shares of Deluxe, the leading check printer that many investors had abandoned, have tripled over the past year thanks to cost cutting under a new chief executive.
● Oddball companies. Certain companies have revolutionary business models that are poorly understood, resulting in cheap stock prices. Classic examples are Southwest Airlines, Dell and Kinder Morgan.
● Discount to the sum of the parts. Many companies lend themselves to valuing their different pieces and can be a great buy if the whole is trading at a sufficient discount to the pieces. We own Tyco because we think the three companies that will emerge from it in the next few months are worth more than $40, versus today’s share price below $33.
Whitney Tilson is a money manager who co-edits Value Investor Insight and co-founded the Value Investing Congress. feedback@tilsonfunds.com

India Funds Revisited

2007-05-12T22:01:00.000-07:00

In this blog, we have looked at emerging market economies and the options available to US investors to get into such markets. One of the hot emerging markets is India. In this blog we have looked at Indian equities and funds quite a few times. We will revisit the India funds again to see if they present an opportunity or two.

First a note about the Indian economy and stock markets.

The economy has been growing at a fast pace, inflation has also been growing at around 6% range flaming fears of overheating or an outright crash. In order to eliminate this scenario, the Indian central bank has increased interest rates and has not interfered with the strengthening Indian Rupee. The strength in the Indian currency will most likely hurt the Indian exporters but may help reduce inflation.

The Indian stock market is an old institution, the oldest in Asia. However, the market is loosely regulated and has had a couple of major scandals in the nineties. The market is also known for its major peaks and valleys. In FY07, the Indian stock market hasnt done particularly well and this is a good sign for investors. The Indian stock market has been flat for the year while many other indices around the world have hit new highs.

The India funds of interest to us are IIF, IFN, MINDX, ETGIX, EEB, ADRE, EEM and VWO. EEB, EEM and VWO are not pure India plays but provide exposure to India. Let us compare these funds and see the pros/cons of each.

IIF is Morgan Stanley India Investment Fund. It is currently trading at almost 12% discount to NAV. The fund has an expense ratio of 1.35%. The fund hasnt kept up with the BSE Sensex Index in the past and the performance of the fund and charts were discussed in the previous article.

IFN is another India fund. It carries a slightly higher expense ratio of 1.41% and has a lesser discout of 11% to NAV. This fund has also lagged BSE Sensex index. This fund has returned -10% so far this year.

MINDX is a mutual fund and has done better than IIF and IFN thus far in the year. This is largely because the mutual fund doesnt develop a large discount or premium to NAV. MINDX has an expense ratio 1.41% and has a separate management fee of 0.7%.

ETGIX has also done relatively well but has underperfomed MINDX. The fund has a front end load of 5.75% and management fee of 2.14%. This is not a good fund for individual investors with less than a million dollars of capital.

EEM has a 5.68% exposure to India, the lowest amongst the BRIC countries. EEM has a larger exposure to Russia, Chian and Brazil.

VWO has a larger 6.1% exposure to India. Similar to EEM, it has larger exposure to other BRIC countries.

From a performance point of view, EEM has done fractionally better than VWO in 2007 despite a higher expense ratio. In the past, EEM has done somewhat better than VWO.

EEB has a larger exposure of 13.5% to India. EEB is concentraded on BRIC and mainly BIC. The growth of Chinese market has helped this fund out perform both EEM and VWO thus far in 2007.

ADRE has a 7.88% exposure to India but is based off the ADRs. It has a lower expense ratio of 0.3% compared to other funds. This fund has a larger exposure to China and lesser exposure to Russia. This has done better than both EEM and VWO thus far this year.

In comparison, an emerging market fund with a cocktail of countries might prove to be a better investment in the longer term as opposed to one country alone. There are several choices available in this category for savvy investors.

Infosys Analysis

2007-05-06T07:31:00.000-07:00

In this blog, we have looked at Infosys and we will take a look again to see how the company is doing.

Infosys is an Indian company that trades on Nasdaq. The businesses the company is into is noted below from its web site.

Infosys Technologies Ltd. (NASDAQ: INFY) provides consulting and IT services to clients globally - as partners to conceptualize and realize technology driven business transformation initiatives. With over 72,000 employees worldwide, we use a low-risk Global Delivery Model (GDM) to accelerate schedules with a high degree of time and cost predictability.

As one of the pioneers in strategic offshore outsourcing of software services, Infosys has leveraged the global trend of offshore outsourcing. Even as many software outsourcing companies were blamed for diverting global jobs to cheaper offshore outsourcing destinations like India and China, Infosys was recently applauded by Wired magazine for its unique offshore outsourcing strategy — it singled out Infosys for turning the outsourcing myth around and bringing jobs back to the US.

Infosys provides end-to-end business solutions that leverage technology. We provide solutions for a dynamic environment where business and technology strategies converge. Our approach focuses on new ways of business combining IT innovation and adoption while also leveraging an organization's current IT assets. We work with large global corporations and new generation technology companies - to build new products or services and to implement prudent business and technology strategies in today's dynamic digital environment.

First, let us look at the financials. For FY07, revenues increased by 44% and profits increased by 53%. For FY08, the company expects revenues to grow by about 30% compared to FY07. Profits will probably grow at a faster pace of about 40%.

The main concern with the outlook is the increased cost of hiring and retaining employees. Infosys pays about $7000 per entry level employee in India and this price is expected to go up by about 15% on the average in the next two years. The company is also increasing the salary of overseas employees by about 5-6% this year compared to about 3% last year. In addition to this, the company is also getting squeezed by the sudden appreciation in the Indian currency of about 10% in the last month and half. Hopefully the company has hedging operations - otherwise this is a double whammy of higher salaries causing 25% increase in costs.

In the conference call, the company talked about some of these challenges. Previously, the company only recruited engineering graduates - now it recruits 10% of its work force from non science and engineering fields. One can see this percentage going up as there is more demand for skilled labor.

Infosys is a well run Indian company - probably the best of the outsourcing companies by far. The management is well known for adding share holder value and for ethical behavior. While the stock is not cheap - given its growth rate, this is a good buy during market dips. It is already the top Indian company in all the emerging market funds that have exposure to India.

Value or Growth?

2007-05-05T16:18:00.000-07:00

We looked at different ETFs to invest in December 2006 starting with this article. Let us revisit the large value vs growth segments to see how things are faring in 2007.

We looked at the large cap segment in December 2006 and analyzed a couple of ETFs. In this segment, we will look at large cap segment again and compare a few ETFs available in this space.

From vanguard, we have VTV for large value, VV for SP500 index and VUG for large cap growth.

From iShares, we have IVE for large value, IVV for SP500 index and IVW for large growth.

Comparing the Vanguard ETFs, the value fund VTV has done better than both SP500 and the growth funds. A chart showing the relative performances can be found here.

Comparing iShares ETFs, the value and SP500 index have done better than the growth segment which includes technology stars like Microsoft and Google. A chart that shows the differences is noted along with.

In 2006, value segment far outperformed both the growth and SP500 indices. Although the outperformance isnt as obvious in 2007, let us look at the P/E ratios where available to compare the funds.

VUG has a P/E ratio of 21.1 and P/B ratio of about 3.9. VV has P/E ratio of 16.9 and P/B ratio of 2.8. VTV has a P/E ratio of 14.2 and a P/B ratio of 2.2. These numbers were updated as of 3/30/2007.

From iShares, IVE has a P/E of 18.84 and a P/B of about 3.01. IVW has a P/E of 21.4 and a P/B of about 4.93. IVV has a P/E of 20 and P/B of 3.93. These numbers were updated as of 3/30/2007.

Comparatively, value funds carry less risk because of the lower P/E numbers. One thing to note though is that the value fund is dominated by oil and gas companies who have done relatively well thus far into the year. The growth funds haven't done as well as SP500 or the value funds historically. This year the earnings for the technology companies was expected to accelerate so it will be interesting to see how the rest of the year plays out. Value is definitely the defensive play and growth is more of a speculative play for 2007.

Berkshire Q1 Earning Release

2007-05-04T20:12:00.000-07:00

In this blog, we have analyzed Berkshire quite a few times, especially as a stock that has been undervalued and as a good buy. Now, that the Berkshire faithful are getting ready to celebrate another annual meeting at the woodstock of capitalism in Omaha, Nebraska, the Q1 results are out. Let us go through some of the numbers.

Berkshire is a conglomerate with many old economy industries varying from candies to carpets and paint. It also does a significant portion of its business in insurance. Berkshire is run by the iconic figures Warren Buffett and his pal Charlie Munger.

Let us briefly look at the earnings in Q1. The total income after taxes in Q1 was 2.595 billion. This compares to earnings of 2.313 billion in 2006. The year over year increase is 12.19%. In the quarter, the cash flows from operating activities was 4.625 billion dollars compared to 2.359 billion dollars in 2006. 5.3 billion dollars worth of equity securities were purchased in the quarter. Despite the heavy buying, total cash on the balance sheet increased by 1.5 billion dollars.

The Equitas deal also closed in the quarter which added 7+ billion dollars of float to the balance sheet. Berkshire provides an additional 5 billion dollars of coverage expected to be paid out in the course of next forty years. The name of the game here is to make money on the float before the time comes to pay out. The pay out period is expected to be upto 40 years. The company also boosted the loss reserves to conservatively account for the deal.

In Q1, the revenues from operating businesses increased by 47% compared to Q1 of 2006. The earnings from operating businesses increased by 25% in one year. The increase in profits by operating subs with old line businesses would put the dot coms and internet companies to shame.

Given the rise in SP500 since April ( after the quarter close ) of about 5%, one can also expect Berkshire's equity position to also have improved in the same period by a similar or higher percentage. The book value for Berkshire is about 110 billion dollars at the end of Q1 and the overall market cap of the company is only 165 billion dollars. While Berkshire's value has increased, its stock price has dropped in the year. One can expect the stock price to rally at some point in the year.

My estimate of Berkshire's intrinsic value is 139,000 dollars/class A share. The stock is selling at a discount of 27% to its intrinsic value and looks like a good buy at current prices.

MSFT earnings update

2007-04-26T20:13:00.000-07:00

In the previous post, we looked at Microsoft valuation from several angles and found Microsoft stock to be not so attractive. In this post, we will take a look at the earnings from the most recent quarter.

The operating margin for the company as a whole declined by 0.25 points in the first nine months of this fiscal year compared to 2006. This isnt a good sign - indicating that XBoX, MSN and other money losing divisions arent executing well.

When looking at free cash flow, the figures arent impressive either. The company gained a bit from exchange rates, increased amortization and slight benefit from stock based compensation. The company spent 5.6 billion issuing new stock and 20 billion buying back stock from the open market. So despite the massive spending on stock buy backs, the outstanding stocks declined only by 4.4%.

Overall, Microsoft's earnings surprise is not built on a solid foundation. The problems with capital allocation continue to persist. In addition, the company isnt making inroads in the search or ad business. The next year would be the make or break year for Microsoft.

MSFT Analysis

2007-04-22T16:58:00.000-07:00

Microsoft is an interesting company. It was a feared technology behemoth a few years back but the stock return has been lackluster for the past nine years. In this segment, we will analyze Microsoft from three angles. (a) Discount cash flow analysis (b) Compare it to the 10 year bond and (c) finally analyze it with the option contracts.

One of the main complaints against Microsoft is that it doesnt know how to allocate capital. This part was covered in great detail in the following story. As the article points out, the XBoX division has bled 5.4 billion on 21 billion of investment in the past five years. A 2% return on 21 billion over five years would have yielded 2.1 billion to the share holders. If it were distributed as dividends, it comes to about 21 cents a share, not exactly chump change.

In addition to XBoX, the other divisions such as MSN, Mobile and Embedded Devices and Microsoft Dynamics have been bleeding cash. Only the windows and office divisions have been profitable and have been keeping Microsoft aloft.

First, let us look at Microsoft's discount cash flow model. The cash flow has been declining in the past few years and one can expect the trend to stabilize in the upcoming years but not subside. Let us look at the free cash flow in the past eight years.

9,447.0 13,082.0 12,319.0 13,739.0 14,906.0 13,517.0 15,793.0 12,826.0 11,917.0

As one can notice, the cash flow has been trending downwards primarily because of XBox and MSN divisions.

A discount rate of 8% to 10% range gives a valuation in the range of 175 billion to 225 billion. The valuation is based on free cash flow growing at the rate of 8% per year which is optimistic. The current Microsoft market cap is about 280 billion dollars.

The second approach is based on EPS and comparison to the 10 year bond. If the analyst EPS of 1.47 and 1.64 for FY07 and FY08 holds true, a stock price of 29.4 and 33.4 seem appropriate. Looking at the current price of Microsoft, the upside in a year's time is about 13.6% if the company is able to meet the earning estimates.

The third aproach is based on option contracts. Looking at the option contract for January 2009, a range of values between 30 and 35 seem more likely with the median of 32.5 being more likely. This compares well with the long bond comparison approach noted above.

Looking at all the approaches, the upside in MSFT is somewhat limited even in the best of environments. There is significant concern about the cash flows with XBoX and the MSN/Search divisions burning cash with no return in sight. It is unlikely Microsoft will spin off these divisions and fend for themselves. It would be good to have these divisions compete on their own merit without getting a life line from Microsoft.

Two arbitrage deals

2007-04-22T16:50:00.000-07:00

In this article, we will look at two arbitrage deals that may give the shareholder a 6% upside within a month and in the worst case two months.

The first one is FICC and the second one is TNOX. First FICC.

FICC is Fieldstone Investment Corp and is being bought out by CBass, a unit of MTG. ( ticket MTG ). The offer price is $4/share and the deal has got SEC approval. The share holders meeting is scheduled for the 22nd of May and the deal is expected to close soon after. Currently the stock is trading at a discount of 6.3% to the eventual buy out price. While the likelihood of the deal to close is good, it is by no means a done deal. However, low stock volume and steady price indicate that the likelihood of the deal going through is high. If the deal doesnt go through, the share holders wont be left with much.

The second company of interest is TNOX. The company is being bought out by Genentech for $20/share but is currently trading at $18.85. This gives a return of 6.1%. The share holders have already approved the deal but SEC approval is pending. The company is saying that the deal is expected to close in the first half of the year.

Both deals have considerable risk and some upside. If the deals dont go through there is a large downside as well.

Guide to ETF Investing

2007-04-14T22:21:00.000-07:00

Seekingalpha has a guide for ETF investing. The guide is worth a read. It covers the following topics:

1. The factors to optimize for higher investment returns.
2. Why Tech stocks dont work
3. Why one shouldnt buy mutual funds?
4. Advantages of buying ETFs
5. How to assemble and manage a ETF portfolio?
6. Analysis for different situations.
7. Putting everything together

Happy reading at http://etf.seekingalpha.com/etfguide.

Conoco Phillips (COP) Analysis

2007-04-14T21:27:00.000-07:00

In this analysis, we will look at Conoco Phillips in a bit more detail than we did last time. COP ended FY06 with 51.4 $/share book value compared to 37 $/share book value in 2005. The book value improved by about 38%.

Let us look at some of the different segments of Conoco Phillips and how much they contributed to earnings.

E&P section was the highest contributor to earnings. World wide average sales price per barrel of oil was $60.37. For natural gas liquids/barrel, the earnings per barrel was $41.50. The revenues from abroad was about 5.5 billion dollars and was 4.348 billion dollars from the U.S. The average production cost has also gone up at around $5.57/barrel.

The other segment that contributes heavily to COP bottom line is R&M segment. R&M is the refining arm of COP. The refining segment resulted in 4.481 billion in income in 2006.

The chemicals segment resulted in 492 million dollars of income. This segment produces petrochemicals from natural gas, liquids and other feed stock.

Emerging Business segment has a net income of 15 million in 2006.

For 2007, the company plans to invest 13.5 billion in capital expenditures. The company plans to pay out about 3 billion dollars in dividends. The remaining cash flow is used to pay out debt and buy back shares. Last year, the cash flow in COP was 21 billion dollars. The total cash flow is entirely dependent on the crude oil prices. It is likely that the crude oil prices will hower around $60 for 2007.

The company expects to generate about 3-4 billion dollars from the rationalization of assets and has a plan to buy back stocks worth 4 billion dollars. The capital expenditures for 2007 has been reduced by about 2.5 billion dollars because of the scaling back of cost intensive projects. One can expect the company to reduce debt by about 3-4 billion dollars from the current level of 27 billion dollars. The company has debt obligations of about 3 billion dollars in 2007. The Venezuela liability to COP is about 2 billion dollars in the worst case.

COP is still cheap compared to its peers Chevron, Exxon Mobil and Petro China. However, COP carries significantly higher amounts of debt on its balance sheets.

Google and Doubleclick deal

2007-04-14T20:28:00.000-07:00

In this blog, we have looked at google a few times. In this article, we will take a look at the double click deal to see Google prospects.

First, let us look at Google's earning yield. The trailing earning yield is 2.1% and the forward earning yield for 2007 is 3%. The expected earning yield for 2008 is 3.95%. The 10 year bond is yielding 4.76% at the moment and is more attractive as an investment than Google stock.

Secondly, Google's competition is intensifying. Yahoo!'s Panama project seems to have started well and Microsoft's search/ad strategy isnt firing yet. However, Microsoft is not expected to give up easily - expect Microsoft to continue pouring money into this space till it captures some market share or the business itself is no longer relevant. We can take cues from the way Microsoft battled AOL in the last one decade. MSN internet access got to be profitable after losing money for years.

One thing that has changed about Microsoft is that it cant afford to spend money as freely as it did in the past as it has quite a few business divisions that are leaking money.

This brings us squarely to the double click deal. At 3.1 billion dollars a year and 1200 employees, is it a good deal for Google?

First, we have to look to see if the deal is accretive to Google's bottomline. Taking into account its 2007 earning yield, double click must generate about 90 million in profit to be comparable to Google's earnings and grow at around 30% pace in the coming year.

However, it is likely that DoubleClick's profits are far lower as Google paid for the entire deal in cash. Since cash is earning a higher yield in treasury bonds, it was a bit surprising that Google paid cash for the deal.

DoubleClick has about 1200 employees and if Google keeps them all, it will end up shelling out about 150-200 million dollars a year in employee salary/benefits alone. Moreover, this deal is unlikely to provide a moat to Google against Microsoft and Yahoo! as these companies already have a significance presence in the display ads market place.

It is difficult to understand how this deal is beneficial to Google at the price paid. It will be interesting to see how the stock will perform in the next couple of years.

UPS Analysis Update

2007-04-08T13:39:00.000-07:00

In previous articles, we looked at UPS and Fedex respectively. Both the stocks have gone down somewhat since then and are relatively cheap. Let us look at these stocks, specifically UPS to consider its prospects for the next several years.

First, some high points from UPS annual report. UPS is going to celebrate its centennial this year. UPS annual report claims industry leading margins at 16.8%. For UPS, management expects 6-10% growth in 2007 over 2006. 2007 is decidely lacklustre year for this segment making it a good time to acquire shares in this industry.

UPS expects organic revenue growth of 6-8% between now and 2010 - getting the overall revenue to about $60 billion. EPS componded is expected to grow between 9 and 14%. This is good news for share holders. At the low end, the upside to share price is 40% from the current levels and at the high end, the upside is more like 70%. This is with a P/E of 18. Meanwhile, UPS will continue to pay out about 40% of the income in dividends - this comes to 2.4% yield per year. Four four years, this comes to about 9.6% over four years - it is likely that dividends will increase and the yield will be will over 10% over four years. In total, one can look at returns of 50% at the low end and 80% at the high end including dividends. This is a good pay out for the current investment.

Looking at the balance sheets - here are some trends for the past five years.

Growth of US Domestic Package - 4.6% per year
International Package - 14% per year
Supply chain and freight - 29% per year

Net income growth for the past five years is - 5.7%
EPS has grown at a rate of 6.4%
Dividends per share has increased at a rate of 15%.

The number of shares has declined in this period by 4%.

Roth 401(k) or Roth IRA?

2007-04-03T21:04:00.000-07:00

In this article, we will take a look at two schemes - a Roth 401(k) and Roth IRA and see the pros/cons of both.

Wikipedia has a good description of Roth IRA. There is also a special provision where people not eligible to contribute to Roth IRA can contribute to IRA and then convert the assets to Roth IRA at a later date.

First some background on Roth IRA and IRA.

On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006. This law made permanent increased contribution limits to IRAs (including Roth IRAs) that would otherwise have expired after 2010. It also made permanent the Roth 401(k), which would otherwise not have been available after 2010. For additional information, see the Roth 401(k) Web Site. On May 17, 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 into law. This tax bill included a provision dealing with conversions of traditional IRAs to Roth IRAs. Starting in 2010, the existing $100,000 income test for converting a traditional IRA to a Roth IRA will no longer apply. Conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012. For additional information, see the statutory provisions and the conference report.

IRA Taxation:When you take money out of an IRA, you pay income tax on all or part of it, depending on whether your original contributions were tax-deductible or not. If your contributions were taxdeductible (in other words, made from pre-tax income), you’ll pay income taxes on the entire withdrawal. If your contributions were not deductible (in other words, you used after-tax dollars,) you generally will be taxed on the earnings only at the time of withdrawal.

If you made both deductible and non-deductible contributions, then each IRA withdrawal is taxed in proportion to the mix of deductible and non-deductible contributions in all your IRAs. For more information on calculating the tax, see IRS Publication 590.

Contribution Limits:

Year Traditional/Roth
2006 $4,000
2007 $4,000
2008 $5,000
2009 $5,000

The Roth 401(k), is also permanent. Roth 401(k) is similar to Roth IRA except that the plan works as part of the 401(k) plan. One has to forego tax deduction now to participate in the Roth 401(k) plan. Also - one has to live with the limited investment options available in the 401(k) plan.

Is it possible to have the best of both worlds? The answer is yes, absolutely. One can contribute to the traditional IRA and convert it to Roth IRA in 2010. Meanwhile, one can continue contributing to 401(k), maxing out the contributions if possible.

In 2007, there is time till 17th of April to contribute to IRA. I am going to avail this opportunity to open an IRA account. I plan to convert this to traditional Roth IRA in 2010. Meanwhile, I participate in a regular 401(k) at work where I get matching contribution and tax savings.

AIG Analysis

2007-03-18T11:56:00.000-07:00

In this segment, we will look at AIG, a Dow component and look at its prospects. AIG's business is described as follows in the 10-K.

AIG’s General Insurance subsidiaries are multiple line companies writing substantially all lines of commercial property and casualty insurance and various personal lines both domestically and abroad. Domestic General Insurance operations are comprised of the Domestic Brokerage Group (DBG), Reinsurance, Personal Lines, and Mortgage Guaranty.
AIG is diversified both in terms of classes of business and geographic locations. In General Insurance, workers compensation business is the largest class of business written and represented approximately 15 percent of net premiums written for the year ended December 31, 2006. During 2006, 8 percent and 7 percent of the direct General Insurance premiums written (gross premiums less return premiums and cancellations, excluding reinsurance assumed and before deducting reinsurance ceded) were written in California and New York, respectively. No other state accounted for more than five percent of such premiums.
The majority of AIG’s General Insurance business is in the casualty classes, which tend to involve longer periods of time for the reporting and settling of claims. This may increase the risk and uncertainty with respect to AIG’s loss reserve development.

Insurance, especially long tail insurance can make the earnings lumpy. So, in this segment, let us look at various business lines to see how things look like.

The various business lines of AIG are:

DBG:

AIG’s primary Domestic General Insurance division is DBG. DBG’s business in the United States and Canada is conducted through American Home, National Union, Lexington, HSB and certain other General Insurance company subsidiaries of AIG. During 2006, DBG accounted for 54 percent of AIG’s General Insurance net premiums written.

Reinsurance:

The subsidiaries of Transatlantic Holdings, Inc. (Transatlantic) offer reinsurance on both a treaty and facultative basis to insurers in the U.S. and abroad. Transatlantic structures programs for a full range of property and casualty products with an emphasis on specialty risk. Transatlantic is a public company owned 59.2 percent by AIG and therefore is included in AIG’s consolidated financial statements.

Personal Lines:

AIG’s Personal Lines operations provide automobile insurance through AIG Direct, a mass marketing operation, the Agency Auto Division and 21st Century Insurance Group (21st Century), as well as a broad range of coverages for high net-worth individuals through the AIG Private Client Group. 21st Century is a public company owned 61.9 percent by AIG and therefore is included in AIG’s consolidated financial statements. During the first quarter of 2007, AIG offered to acquire the outstanding shares of 21st Century not already owned by AIG and its subsidiaries.

Mortgage Guarantee:
The main business of the subsidiaries of United Guaranty Corporation (UGC) is the issuance of residential mortgage guaranty insurance, both domestically and internationally, on conventional first lien mortgages for the purchase or refinance of one to four family residences. UGC subsidiaries also write second lien and private student loan guaranty insurance.

Foreign General Insurance:

AIG’s Foreign General Insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance companies. The Foreign General Insurance group also includes business written by AIG’s foreign-based insurance subsidiaries. The Foreign General Insurance group uses various marketing methods and multiple distribution channels to write both commercial and consumer lines insurance with certain refinements for local laws, customs and needs. AIU operates in Asia, the Pacific Rim, Europe, including the U.K., Africa, the Middle East and Latin America. During 2006, the Foreign General Insurance group accounted for 25 percent of AIG’s General Insurance net premiums written.

For followers of Berkshire, the AIG credit rating is not as good as Berkshires. In 2005, the AIG credit rating was downgraded and as a result, AIG had to put up significantl collateral. In contrast, Berkshire enjoys the top most credit rating that can be given.

2006 was an unusually good year for AIG as was the case for insurance companies in general because of the absence of major catastrophes in the world. In 2005, AIG paid out about three billion for the Katrina and other related catastrophes. AIG's business segment revenues and incomes were as follows for 2006.

General Insurance - 49.2 billion
Life insurance and retirement services - 50.1 billion
Financial Services - 8 billion
Asset management - 5.8 billion

The income was as follows:

General Insurance - 10.4 billion
Life Ins and Retirement Service - 10 billion
Financial Service - 0.5 billion
Asset Management - 2.3 billion

The major uptick in income came in the general insurance section where the income increased from 2 billion to 10 billion. Income from Financial Services declined significantly by about 2 billion in 2006 compared to 2005.

AIG is expanding aggressively in Asia and so far about 20% of its revenue is from Asia. The company is seeing growth opportunities in China, India and Japan.

One can expect the insurance rates to be soft this year - car premiums are staying flat or declining because of the decrease in accidents. The re-insurance sector is also expected to be soft this year because of catastrophe free year of 2006.

The value line investment survey published a survey of AIG. According to valueline, AIG's EPS will be 7.80 by 2011 and book value will be $60.00. Valueline thinks the share price will be 135 to 180 dollars per share in this time frame. However, this assumes the Price/Book and Price to earnings ratios to remain high or higher.

Overall, the value line forecast seems a bit aggressive to me including the low end. While AIG is a good company, my opinion is that Berkshire is a very compelling investment as well. Berkshire does insurance better than AIG and has other well diversified business and stock holdings. Currently berkshire is selling for about 28% discount to fair value.

MMM (3M) Analysis

2007-03-11T16:06:00.000-07:00

3M is a diversified technology company with a global presence in the following businesses: industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services; and electro and communications. 3M is among the leading manufacturers of products for many of the markets it serves. Most 3M products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies.
At December 31, 2006, the Company employed 75,333 people, with 34,553 employed in the United States and 40,780 employed internationally.

The company is growing at around 7-8% year over year but is facing tough comparisons this year compared to last with lower EPS this year compared to last. This is one of the reasons the stock is down. The analysts are expecting flat to slight growth this year compared to the previous year. Next year is expected to be somewhat better with a growth of about 10-12%.

Let us briefly take a look at the revenues by geographic region and growth by geographic region. The revenues by geographic region look as follows:

US - 38.6%
Asia Pacific - 27.3%
Europe - 25%
Latin America and Canada - 9.1%

The EPS has grown at around 9% for the past ten years. The top line growth is more abysmal at around 4.5% per year for the past ten years. The operating profit has increased at the rate of 6%.

In the same period, the number of outstanding shares has declined by about 8%. One can expect the total number of shares to decline slowly in the upcoming years. The cash flow from operations continues to be strong - growing at around 10% per year. The debt has also increased in 2006 compared to 2005. The dividend has grown at around 8% per year for the past five years. One can expect this ratio to continue in the upcoming years.

Indian market overview

2007-03-11T11:16:00.001-07:00

In the previous article, we looked at major India funds and compared their performance against the BSE Sensex Index. We found that the mutual funds werent doing well and were lagging the BSE Sensex by a large margin. When we analyzed the Chinese market, we found the results to be identical - the funds lagged the index by a large margin.

The BSE Sensex index went down by about 15% since its peak and it is a good thing. People may think that the market should go up but this isnt the case. A correction like the one we have seen is very healthy as it ensures the long term health of the market and killing excessive speculation.

Let us take a look at different funds to see how things look like. Let us compare the charts of the various India funds and EEM looks like when comparing against the BSE Sensex Index. The comparative charts of the funds and their performance is noted below:

Chart comparing BSE Sensex vs other funds

Even with this correction - the expected return for Indian stocks in a best case scenario is 10-12% for the next four - five years. A deeper correction will provide more upside if the economy is managed well in the next several years.

Berkshire Hathaway (BRK) Valuation

2007-03-01T21:47:00.000-08:00

Today, Warren Buffett's holding company, Berkshire Hathaway released its earning report. The results were stunning - with 16.9 billion dollars of net worth added.

The annual letter provides a lot of details and is a joy to read. The worlds best investor clearly delivered in 2006 while adding significant positions to the equity portfolio and buying companies outright.

In this section we estimate the intrinsic value using two methods. First one is book value * multiple. The second one is a multiple of the book value.

For the first method, we will use two multiples - 1.9 at the low end and 2.0 on the high end. This gives a per share value of 132.5K at the low end and 139K at the higher end. The mid point between these two is 135.75K.

The second method would involve investments + sub earning * multiple. This is 80636 + ( 3625 * 12 ). This gives a value of 124316. This assumes that the insurance operations are worth only the investments per share. If we assume the insurance businesses are worth atleast 10 billion on top of the per share investments, it adds 6,600 per share. This gives a value of 130916.

Either way, we are looking at a valuation of 125K+ and currently the shares are selling at a 25% discount to intrinsic value.

Market Correction

2007-02-27T19:36:00.000-08:00

Today, the US Market reacted severely to the correction in the Chinese market of approximately 9%. The emerging market funds took a severe hit - declining by about 7%. The emerging market funds declined more than needed as it has only 11% exposure to China. The Korean stocks are undervalued compared to the SP500 and the market overreacted.

Overreacted is the right word as the fundamentals dont support the declines we saw today. The oil prices went up but the oil and oil services stocks declined with the broader market. The SP500 index was not overvalued before today's sell-off and it isnt overvalued now. There was panic selling all across the board with broad helping from automatic stop loss orders.

It didnt help that Alan Greenspan thinks the business cycle is peaking and the US economy is headed for a recession at the end of 2007 or early 2008. Some of the emerging markets - especially China, India and Mexico was ripe for a correction. Even though the prospects for emerging markets still remain very good. A correction is healthy and welcome as it prevents overheating and takes speculators out.

I expect the US market to recover somewhat in the next few days but it probably wont return to its previous levels till later in the year when the economic outlook becomes clearer.

I am holding tight and building up my cash position. I am expecting some great buy opportunities to be available in the upcoming months. It should be possible to buy great companies at bargain prices and I am looking forward to the opportunity to load up the truck.

Conoco Phillips update

2007-02-25T10:53:00.000-08:00

In a previous article we looked at Conoco Phillips fundamentals and found it to be a value play among the energy players.

We will quickly take a look at the stock in light of the latest 10-K filing and see how the changes look like.

First the balance sheets and cash flow overview. The debt carried on the balance sheet declined by 4 billion to $23 billion. The book value per share increased to $50.5. The ratio of the current market value to book value is 1.33 for COP. This compares to 3.76 for Exxon Mobil, 2.29 for Chevron and ~3 for Petro China. In my opinion, this makes COP a screaming buy among the oil majors today.

For the year, COP spent 925 million dollars buying back stock and issues 2.25 billion in dividends. The plan of buying back stock makes the most sense as the stock is undervalued at the moment.

In this year, we expect COP to continue to pay down debt while buying back stock and increasing dividends. The debt should go down from the current 23 billion levels to below 20 billion level probably to 17-18 billion. This should lead to increases in book value of the company to 53 to 54 dollars a share all else being equal. This should help the stock break the $70 barrier and stay there.

Lowes vs Home Depot - updated

2007-02-25T07:13:00.000-08:00

In a previous article, we looked at Lowes and HD. In that article, we found that long term prospects bode well for both Lowes and HD. The analysis still remains the same but the price points have changed somewhat and the discount isnt that deep any more.

Home Depot had a few issues to sort out especially the compensation and integrity of management. The departure of Nardelli is welcome news to the share holders of HD. However, it is not clear that the mess that Nardelli created may clear anytime soon. I used to have the Pavlovian habit of going to Home Depot as it is located closer to my home compared to Lowes. The poor customer service and Nardelli behavior have helped kick my Pavlovian habit - I now go to Lowes exclusively.

I like the way Lowes is doing its business - over Chrismas, I was able to find a few interesting toys at Lowes. I am also seeing more traffic at my local Lowes store now than was the case before. This is one micro example but just points to how things have changed in a short time.

First, let us look at the performance of the two stocks over the last three months, six months and a year respectively.

3 month chart

6 month chart

1 year chart

Lowes has done as well or better than Home Depot in each of these periods. The two year and five year charts also point in favor of Lowes.

Having said this, let us look at the fundamentals briefly. Lowes has a trailing P/E of 17.29 and a market cap of 53 billion. The stock is still at a discount to its fair price - although the discount isnt as deep as it once was.

Home Depot has a market cap of 83 billion, a trailing P/E of 15. The stock is at a discount to its fair price but the discount is primarily because of concerns over growth and the management shakeup. Lowes is growing even in a dismal housing market where as Home Depot is stagnant and its year over year sales are down more sharply.

While housing is the main factor affecting both companies, Lowes better execution and closeness to the customers should help it do better than Home Depot in the next five years.

Comparison of large cap asset class

2007-02-21T05:44:00.000-08:00

In december, we looked at different asset classes and evaluated the interesting asset classes for investing. Our bias for investing has always been value. Consequently, in this blog, we have taken a bearish view on stocks such as Google, Ebay, Amazon.com etc.

In this segment, we will look at large cap domestic equities and again look at value, blend and growth segments to see how things look like.

We will look at the ETFs offered by Vanguard and iShares respectively. First iShares ETFs. iShares offers several ETFs in the large cap domestic equity class but we will look at three ETFs in particular.

The three ETFs of interest are:

IVW -large cap growth - P/E of 22.38 and P/B of 4.92
IVV - mimics SP500 - P/E of 20.69 and P/B of 3.85
IVE - large cap value - P/E of 19.5, P/B of 2.84.

The returns on these three for the past three months can be visualized in the following chart.

Chart1

The chart shows the value segment outperforming the growth segment by about 3% points. The value segment is also outpacing SP500 by about 1.5% percentage points.

The second category would be the Vanguard ETFs. Vanguard has VTV, VV and VUG.

VUG - large cap growth has P/E of 21x, P/B of 4.0x and earning growth of 22%.
VV - large cap blend, mimics SP500, has P/E of 17.2x, P/B of 2.9x and earning growth of 18.8%
VTV - large cap value, P/E of 14.5x, the P/B of 2.3x and earning growth of 15%

The numbers are updated as of 1/31/2007 by Vanguard. The earning growth numbers are a bit suspect as the SP500 earning growth has moderated to about 11% YoY as of the new year.

The returns from these three funds over the past three months is noted below.

Chart2

As seen with iShares, the Vanguard funds also show the value segment outpacing the blend and growth segments in the past three months. While the difference isnt as great as was the case with iShares, value still outperformed growth by about a percentage point.

It is difficult to predict which category will do better in any given year. Growth is expected to do well this year because of the accelerating revenues from the technology sector. A defensive investor may look at various factors before committing money to an asset class. The usual risk factors for equities apply.

China Funds Comparison

2007-02-19T20:00:00.000-08:00

In the last article in this blog, we looked at India investments through four mutual funds. In this section we will look at China mutual funds and compare it to the Shanghai Composite Index. Comparisons of the like are helpful to identify the asset classes that one can invest in with fair degree of confidence.

Some of the China funds of interest are noted below:

CHUSX Alger China-US Growth
DPCAX Dreyfus Premier Greater China
EVCGX Eaton Vance Greater China
FHKCX Fidelity Greater China
GCHAX Alliance Bernstein Greater China
GOPAX Gartmore China Opportunities
ICHKX Guinness Atkinson China & Hong Kong
MCHFX Mathews China Fund
NGCAX Columbia Greater China
OBCHX Oberweiss China Opportunities
TCWAX Templeton China World
USCOX US Global Investors China Region Opportunity

While we are not going to look at the expenses of individual funds, we will look at the performance of each fund compared to the Shanghai Composite Index.

The first chart below compares the Shanghai Composite to the first six funds noted above.

Chart1 Shanghai Composite vs First six funds

The first chart clearly shows the Shanghai composite outperforming the funds by about 80%.

Chart2 Shanghai Composite vs the last six funds

Again, all the managed funds lagged the index significantly. OBCHX was the best of the bunch trailing the index by 70%.

Next we compare the Shanghai Composite Index to FXI and PGJ. The comparison charts are noted below.

Chart3 Shanghai Composite vs FXI and PGJ

Both FXI and PGJ havent performed as well as OBCHX. FXI has done better than PGJ but lags behind OBCHX.

The main thing to note here is past performance is no guarantee of future performance. The charts presented in this blog present the funds for the past one year without looking at the focus of each fund in detail. As such, one has to look at the long term prospects, the current holdings and the expense ratio before making an investment decision.

I would also advice the readers to check the disclaimer at the very end of this blog before considering investmenting.

Comparison of India Funds

2007-02-17T21:09:00.000-08:00

Here is the comparison of India funds vs. the BSE Sensex Index.

IIF vs BSE Sensex for the past one year:

http://finance.yahoo.com/q/bc?t=1y&s=%5EBSESN&l=on&z=m&q=l&c=iif

IFN vs BSE Sensex for the past one year:

http://finance.yahoo.com/q/bc?t=1y&s=%5EBSESN&l=on&z=m&q=l&c=ifn

MINDX vs BSE Sensex for the past one year

http://finance.yahoo.com/q/bc?t=1y&s=%5EBSESN&l=on&z=m&q=l&c=mindx

ETGIX vs BSE Sensex for the past one year

http://finance.yahoo.com/q/bc?t=1y&s=%5EBSESN&l=on&z=m&q=l&c=etgix

Of the India funds available to US investors, MINDX has the best performance vs. the BSE Sensex Index. However the index itself has done significantly better than any of the mutual funds.

EEM vs BSE Sensex

http://finance.yahoo.com/q/bc?t=1y&s=%5EBSESN&l=on&z=m&q=l&c=eem

For the sake of comparison, we compare EEM vs BSE Sensex, the red hot Indian index has done a lot better than the emerging market as a whole for the past one year. However, EEM may offer better prospects for this year as its main component, the Korean market didnt do very well in 2006.

MINDX vs EEM

http://finance.yahoo.com/q/bc?t=2y&s=MINDX&l=on&z=m&q=l&c=eem

EEM handily beat all the India funds with the exception of MINDX. As we have examined in this blog in the past, several publications indicate that Indian market is overheating. The Walstreet journal also carried an article to the same effect this weekend. In contrast, EEM's main component is Korea where the reduced tensions with north Korea bode well to the stock market. South Korea didnt do well in 2006 and given the world wide economic growth, the Korean stock market should do a lot better this year.

In the next article in this blog, we will look at China funds in more detail.

ECR Analysis

2007-02-14T21:08:00.000-08:00

ECR is a public company that is in the subprime lending business. It has faced some tough times of late with losses in 2005 and 2006. Currently, the company's book value is more than the per share value. The company is trading for .93/share where as the book value as of Sept 30th 2006 was $2.07/share.

The company is getting out of the mortgage origination business. It has securitized and is selling its subprime mortgages. The company was expected to pay out $80 million to shareholders one month after the close of its deal to sell the mortgage origination business to Bear Stearns. The company was also expected to pay out another 56 cents a share in dividends. The total comes to 1.36 per share about 40% premium to the current valuation.

The press release put out by the company gave the following outlook for dividends.

1. First it says a payment may not be made before March 30th( I think this is the 80 cents/share that was supposed to have beenpaid within 30 days of bear stearns deal closing )which wont be forthcoming now.

2. The second amount is 56 cents/share - it seems this paymentwill be made in two parts at worst ( by June 29 ) or in one lump sumby March 30th. Most likely, the 80 cent payout is likely be replacedby this payment.

3. Additional payments may be made outside of these two payments in the future. ( dates unknown )

4. Even then, the company re-affirmed the payment of $1.34 - timing isthe question mark. Future payments are now dependent on "cash flowsfrom ECC Capital's residual interests in securitizations and thecompletion of transactions related to the financing of its residuals."

What does this mean? Is the company not able to meet its obligations while the balance sheet is deteriorating? Here is one take on this after studying the last 10-Q in detail.

1. The company had plans to give away $80 million in dividends right after the close of Bear Stearns deal. The company also expected the payment of 33 million to happen over a period of time as opposed to happening immediately. The deal closed about a month and a half later and 33.6 million payment happened immediately. Not all issues regarding the deal are closed and may take some more time for it to close.

2. The company seems to have the subprime default rate under control with adequate provisions for losses. At least it said so in the 10-Q.

3. The CEO bought 500K shares from the co-CEO.

4. My guess is that the immediate payment of 33 million to Bear Stearns ( as opposed to over a period of time ) as well as the 10 million payment to the unit of GMAC caused the cash reserves to dip below the comfortable level for management to give away 8o cents/share dividend immediately.

The company planned to be in existence through 2007 as per the previous 10-Q. It remains to be seen if the company will be liquidated and if so, how soon.

While my estimate is based on the currently available public docuementation, the reality may differ from the estimate. This will become clearer as more information becomes available in due course. In addition, it should be disclosed that I own shares in this company.

Indian economy and stockmarket overheating?

2007-02-09T22:20:00.000-08:00

There were several articles in the past week that focussed on India. The first one was in the economist which wrote that the Indian economy is overheating. The article, which requires a paid subscription described the situation as follows:

THE economy is sizzling and foreign businessmen and investors are swarming to Bangalore and Mumbai to grab a piece of the action. India's year-on-year growth rate could well hit double figures at some point in 2007, and the country may even grow faster than China for at least one quarter. But things are so hot there is a big problem: India's current pace of expansion may not be sustainable.…

If one thought this article got it wrong, the NYTimes carried an article on the same theme. The article was titled "India finds its economy on the verge of overheating". The article had the following to say:

With breakneck growth, an outsourcing industry that leads the world and hundreds of millions of consumers demanding more class and comfort, India has an economy many countries would envy.

But now, after three years of near double-digit growth, signs of a potentially dangerous inflationary spiral are beginning to emerge. Prime Minister Manmohan Singh and his closest economic advisors gathered just last weekend over fears that India’s extraordinary economic expansion was starting to overheat, an issue they labeled as a “key short-term priority.”

As if this werent enough, cnn carried an article titled "India a superpower? Thing again". The article highlighted some of the deep rooted problems in India.

To add more ammo to the overheated debate - the seeking alpha website carried an article that made a compelling case why one should not buy Indian equities at current prices.

Since 1997, the Indian economy has grown 146% at a compound annual growth rate [CAGR] of 9.41%. Over the same time period, earnings of the 30 companies that make up India’s BSE Sensex have grown around 150%. No surprises there. However, over that same 10 year period, India’s BSE Sensex has risen 345% at a CAGR of 16.11%.
In comparisons such as the one above, an abnormal base period can distort the figures. And January 1997 was an abnormal month for the Sensex, characterized by a depressed price/earning [P/E] multiple of 13.5. However, had the Sensex been trading at a P/E multiple of 17, which is the average multiple over the 10 year period, the Sensex would’ve still risen 260%; way above underlying companies’ earnings.

There was another article in the same site that said Indian stocks are losing momentum compared to other stock indices in the emerging markets. But the article also said that so long as the economy keeps growing, there is little chance of a steep correction.

Overall consensus is that the Indian stocks are not cheap at the moment and it is not worth investing more at the current prices.

Decline in SP500 earnings

2007-02-07T19:51:00.000-08:00

CNN carried an article claiming decline in SP500 earnings in FY07 compared to FY06. The article had the following prognosis for SP500

Earnings for the energy sector are expected to fall 2 percent in the first quarter or 2007, dragging on broader earnings growth.
But downward revisions to technology and consumer earnings are also contributing. As of Jan. 1, the tech sector was forecast to post earnings growth of 17 percent, whereas now the growth is set at 12 percent.
The consumer sector was expected to see a decline of 1 percent at the time. Now the decline is pegged at 4 percent.
2007 earnings are currently on track to grow about 7.3 percent, down from a forecast of 9.3 percent on Jan. 1.
Should the numbers hold up, that would make 2007 earnings growth the slowest since 2002, when S&P 500 earnings grew one-tenth of a percent

While this may mean less than average growth for SP500 index in 2007, this may also provide opportunities to buy quality companies at reasonable prices. I already have several companies in my list who I am hoping will decline in price through the summer of 2007.

Wipro (WIT) or Infosys (INFY)?

2007-02-04T07:59:00.002-08:00

One of the readers asked the question - which stock is a better investment Wipro or Infosys? For people that arent familiar, both are Indian information technology companies that do offshore as well as consulting work. Both the companies are listed in the NASDAQ and are competitors to American heavy weights such as IBM and Accenture. We will provide a brief overview of the two companies here.

From Infosys website, the company's description is as follows:

Infosys Technologies Ltd. (NASDAQ: INFY) provides consulting and IT services to clients globally - as partners to conceptualize and realize technology driven business transformation initiatives. With over 69,000 employees worldwide, we use a low-risk Global Delivery Model (GDM) to accelerate schedules with a high degree of time and cost predictability.
As one of the pioneers in strategic offshore outsourcing of software services, Infosys has leveraged the global trend of offshore outsourcing. Even as many software outsourcing companies were blamed for diverting global jobs to cheaper offshore outsourcing destinations like India and China, Infosys was recently applauded by Wired magazine for its unique offshore outsourcing strategy — it singled out Infosys for turning the outsourcing myth around and bringing jobs back to the US.Infosys provides end-to-end business solutions that leverage technology. We provide solutions for a dynamic environment where business and technology strategies converge. Our approach focuses on new ways of business combining IT innovation and adoption while also leveraging an organization's current IT assets. We work with large global corporations and new generation technology companies - to build new products or services and to implement prudent business and technology strategies in today's dynamic digital environment.

From Wipro's website, the company description is as follows.

Wipro becomes the first Indian IT Service Provider to be awarded Gold-Level Status in Microsoft’s Windows Embedded Partner Program
Wipro is the world’s largest independent R&D Services Provider
Worlds 1st PCMM Level 5 software company
Wipro one among the few companies in the world to be assessed at maturity level 5 for CMMI V1.2 across offshore and onsite development centers, 2007
Worlds 1st IT Services Company to use Six Sigma
The pioneers in applying Lean Manufacturing techniques to IT services
World’s first SEI CMM/CMMI Level 5 IT services company
The first to get the BS15000 certification for its Global Command Centre
Functional RFID Enabled Concept Store and Global Data Synchronization Laboratory BS7799 and ISO 9000 certified
Among the top 3 offshore BPO service providers in the world
Wipro is a strategic partner to five of the top ten most innovative companies in the world* (*Technology Review Innovation Index 2005)
Over 40 industry facing ‘Centers of Excellence’
592 clients - 53000+ employees
46 development centers across globe

Now, let us look at the two companies from financial as well as the management view points. We will also see the future trends to see how these two companies stack up against each other.

Market cap and valuation:

Wipro has a market cap of 25 billion dollars. It has a P/E of 42 ( trailing ) and forward P/E of 32. The price to earning growth is at 1.35.

Infosys has a market cap of 33 billion dollars. It has a trailing P/E of 43 and estimated forward P/E of 32. The estimated price to earning growth is at 1.28 - slightly lower than that of Wipro.

From a valuation view point, Infosys and Wipro look quite alike with a slight advantage to Infosys in price to earning growth.

Management:

Wipro is primarily owned by Azim Premji. The management succession is not clear - though most likely it will be family owned in the same way as most of Indias conglomerates. Wipro has had a history of management attrition. In some cases, this has resulted in competitors such as Mindtree.

Infosys on the other hand is not owned by one person and is more egalatarian. The management succession is clear. Infosys is also a storied Indian company as it was the first Indian company to be listed in Nasdaq and the first to be included in the Nasdaq 100 index.

From a management and succession view point, Infosys has the advantage.

Financial Ratios:

Infosys has a dividend yield of 0.9% and Wipro has a dividend yield of 0.6%. Infosys dividend has grown from 5 cents a share in 2003 to 51 cents a share in 2007. Wipro's dividend growth is sketchy - it yield about 11 cents a share now.

Infosys has a return on equity of 36% on the average for the past five years and return on asset of 30%. Both these are phenomenal numbers compared to even the best US based companies.
Wipro has a return on equity of close to 30% and return on asset of about 23% for the past five years. While these numbers are very good, they are not as good as Infosys.

Infosys's top line growth of about 35% in the most recent year moderating from a higher growth of 40%. The EPS growth has also been very strong at around 35% per year.
Wipro has had the top line growth of about 30% for the past five years while the EPS growth has been about 25%.

Infosys has a free cash flow of about 350 million dollars that has been growing steadily. Wipro has a cash flow of 280 million that has also been growing steadily.

Overall, in this section, Infosys is looking a lot stronger than Wipro.

Summary:
From a valuation point of view, niether Infosys nor Wipro is cheap. While stacking the two companies side by side, Infosys has edge in almost all the segments compared to Wipro. The outsourcing/offshoring business is getting to be more competitive but both the companies are now well entrenched and should continue to do well. If I have to allocate my investment dollars between these two companies, Infosys would be my choice.

Google FY06 Analysis

2007-02-01T20:19:00.000-08:00

In the past articles in this blog, we have analyzed Google and have typically taken a bearish view of the stock. Although Google is a strong growth company that is gaining market share in the search space, it doesnt have what one would term a "wide moat". Wide moat is the ability to raise prices and not lose market share. In this article, we will look at Google's FY06 earnings and see the forecast for FY07. We will also look at the analyst estimates ( a consensus target of $600 ) and see if it makes sense. We will also look at the competitors and see how Google compares to Yahoo! and Microsoft.

First FY06 results. The reported EPS is 10.21 per share where as the diluted EPS is 9.94. The diluted share count is 309 million. The year ago figure is 291 million. The share count increased by 6.2% year over year. The EPS was below the analyst consensus estimate of 10.33/share. Consequently the Google shares went down by 3.94% the day after.

The EPS for Google is expected to be around 36% higher in 2007 compared to 2006. While it is impossible to predict the future, the accounting treatment of the stock options and awards will play a large role in the EPS for 2007.

Let us now compare the competitors Google, Yahoo! and Microsoft. Let us look at the different ratios to see how they compare.

Let us start with Yahoo! The ROA and ROE for Yahoo! for the past three years are as follows.

ROA - 11%, 19% and 11.5% respectively.
ROE - 14.7%, 24.2% and 15% respectively.

The numbers for Microsoft are as follows.

ROA - 15%, 18% and 19%.
ROE - 20.3%, 28.8% and 31% respectively.

Let us finally look at Google.

ROA - 19%, 21.6% and 19.24% respectively.
ROE - 26%, 24% and 21% respectively.

Google numbers are pretty good and it is pretty clear that Google is a superior company to Yahoo! The trailing P/E for Google is 48 which is a bit pricy compared to other top companies. The predicted forward growth rate for Google is around 35 for FY07 which is lower than the P/E.

The good news for Google is that it seems to be widening its market share compared to its rivals. Although both Yahoo! and Microsoft are interested in competing, Google seems to be ahead of the curve and increasing the lead every passing year. 2007 should be very interesting as it should show the market trends and future prospects for the search based advertizing. After trailing SP500 in 2006, it is anybodies guess what will happen to Google stock in 2007. One thing is sure - Google share holders can expect a wild ride in 2007.

Johnson and Johnson (JNJ) Analysis

2007-01-27T15:24:00.000-08:00

JNJ is a large company that has excellent profits, strong balance sheet but is growing somewhat slowly. Johnson & Johnson’s worldwide business is divided into three segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. From its 10-K, the business can be described as follows:

Johnson & Johnson and its subsidiaries have approximately 115,600 employees worldwide engaged in the manufacture and sale of a broad range of products in the health care field. Johnson & Johnson has more than 230 operating companies conducting business in virtually all countries of the world. Johnson & Johnson’s primary focus has been on products related to human health and well-being. Johnson & Johnson was incorporated in the State of New Jersey in 1887.
The Company’s structure is based on the principle of decentralized management. The Executive Committee of Johnson & Johnson is the principal management group responsible for the operations and allocation of the resources of the Company. This Committee oversees and coordinates the activities of the Consumer, Pharmaceutical and Medical Devices and Diagnostics business segments. Each subsidiary within the business segments is, with some exceptions, managed by citizens of the country in which it is located.

For the last ten years, the company has never traded at a P/E < 20. This changed in 2005 and 2006 - where the company has traded for a P/E of about 17. Let us look at the JNJ business in some detail and then look at the various valuation ratios and future outlook. The earnings by different segments were as follows. Consumer segment contributes about 10%, pharmaceuticals provides about 45% and medical equipment provides the remaining 45% of revenue for JNJ. Let us look at the growth of each of the segments in 2006 and profitability to see how things stack up. In 2006, the consumer segment grew by 6.2% worldwide, pharma sector grew by 2.8% worldwide and medical devices segment grew by 5.9% world wide. As expected, the growth in the international segment outpaced the domestic segment in all categories. The overall revenue growth world wide was 4.6% year over year. The profit growth world wide was at a slightly higher level at 11.9% year over year. The EPS has increased at the rate of ~11% year over year for the past four years. The top line revenue has increased at the rate of only 5.6% for the past four years. The operating cash flow has increased at the rate of 5.5%. The free cash flow has increased at a slightly higher rate of 5.7%. Share holders equity has increased at the rate of 10.6% for the past four years. The return on equity has been consistently high at around 25%+/year. The return on assets is also pretty good at around +15%/year. The company gives away 40% of the earnings in dividends. The company's margins have also been increasing steadily and stand at around 27% at the moment. The company, while having good prospects, isnt as cheap as it used to be early/mid last year.

Valueline did an independent study that shows the strength of JNJ's balance sheet and also projects future share price growth. Share buy backs as the shares dip or as acquisitions can also add to share holder value. The main ding against the stock is that the top line growth has slowed significantly. Although the balance sheet is strong, the prospect of slow growth is keeping investors away from this stock.

Investing in 2007 - asset class comparison update

2007-01-21T15:04:00.000-08:00

In the article a couple of weeks back, we compared various asset classes and nted the P/E ratios of various funds. Vanguard has finally released the information of their ETFs as of 12/31/06 and the information released by Vanguard is different from what we have noted in this blog. So, in this article, we will go and update the P/E ratios as noted by Vanguard. For the international segment, Vanguard hasnt published information on these ratios.

Large Value

VTV - P/E of 14.7x, P/B of 2.3x, earning growth of 15.6% and ROE of 18.4%

Large Blend

VV - P/E of 17.4x, P/B of 2.9x, earning growth of 18.8% and ROE of 18.8%
VTI - P/E of 17.9x, P/B of 2.9x, earning growth of 18.5% and ROE of 17.9%

Large Growth

VUG - P/E of 21.5x, P/B of 3.9x, earning growth of 22.6% and ROE of 19.1%.

Mid Cap Value:

VOE - P/E of 16.4, P/B of 2.0x, earning growth of 13.2% and ROE of 13.2%

Mid Cap Blend:

VO - P/E of 19.1x, P/B of 2.7x, earning growth of 17.8% and ROE of 15.5%

Mid Cap Growth:

VOT - P/E of 23, P/B of 3.9x, earning growth of 23.2% and ROE of 17.6%.

Small Cap Value:

VBR - P/E of 18.9, P/B of 1.9x, earning growth of 10.5% and ROE of 10.5%.

Small Cap Blend:

VB - P/E of 22.4, P/B of 2.4x, ROE of 11.7% and earning growth of 15.7%.

Small Cap Growth:

VBK - P/E of 27.6, P/B of 3.5x, ROE of 12.8% and earning growth of 23.4%.

Diamond as an investment?

2007-01-16T18:50:00.000-08:00

Diamonds are associated with romance and marriage - thanks to a successful marketing campaign by De Beers, a South African company.

However, of late, the man made diamonds are getting better and are likely reduce the value of diamond as an investment. A better investment is likely precious metals like gold or silver which have to be mined and cant be manufactured in a laboratory.

As the articles in Chemical Engineering News and the more main stream MSN Money show, the man made diamonds are getting to be more mainstream and less expensive than the mined diamonds. It is conceivable that the price points for diamonds will drop significantly in the next ten - twenty years as man made diamonds get to be more mainstream.

Walmart or Microsoft?

2007-01-14T17:22:00.000-08:00

This is a comparison of Walmart and Microsoft to see which one is a better bet for the nex five years. If we are expecting 10% return per year for the next five years for 50% total return, the stock price apprecition would be as follows:

MSFT

31 * 1.5 == 46.5

Walmart

47 * 1.5 == 71

Let us look at the top line growth - Walmart is growing at a rate of 8% at the top line where as Microsoft is growing the topline at 7% per year.
Looking at the bottom line, both Walmart and Microsoft have grown at around 9% per year.

However, Walmart's free cash flow has increased year over year and by about 25% in the past five years. Microsoft's cash flow has declined or remained the same in the past five years. This year, Walmart has taken a special one time charge of 850 million to get out of the German and South Korean markets. This will not show up in the balance sheets next year.

Lastly, let us look at the margin of safety provided by the two stocks. Walmart provides about 20% margin of safety where as Microsoft provides no margin of safety at current prices.

Walmart (WMT) Analysis

2007-01-13T19:13:00.000-08:00

We looked at Walmart and compared it to Amazon.com almost a year ago. The analysis is available at the following link.

In the one year, Walmart has remained stagnant with a lot of negative press and stagnant earnings. The earnings have remained stagnant as Walmart has started pulling out of markets such as Germany where it hasnt been successful. The special charges for discontinuing operations have caused the earnings thus far this year to be somewhat lower than last. Amazon on the other hand has declined from a higher price of $45 to a lower price of $38. Amazon.com still looks pricy and has room to move lower. In this article, we will look at the fortunes of Walmart and see how does it look from an investment view point.

For the first nine months of 2006, the top line revenue growth at Walmart increased by 11% compared to 2005. The operating margin for the first nine months of 2006 is 5.7%. This compares to the operating margin of 5.81% in 2005. The decline in margins is slight and was expected as Walmart tried to increase its same store sales. The company has taken a charge of 894 million to withdraw from unprofitable markets that is expected to be a one time event. As a result of this charge, the bottom line growth is about 6.4% - this excludes the per share loss from discontinued operations.

The share holders equity year over has increased by 17.7% and has increased by 10.5% in the first nine months of the year. The international sales made 22% of the sales volume for Walmart and is also the fastest growing segment. Although Walmart had to close its German and South Korean operations, it is expanding in South America, Japan and China. It also has plans to enter the Indian market through a joint venture with an Indian company.

Walmart's international operations increased by 30% year over year. Walmart's domestic sales increased by 8% year over year. Sam's club was comparitively stagnant with a growth of 4.5% year over year. Although Walmart's gross margin increased year over year, it didnt translate into the bottom line. The capital expenditures by Walmart were about 11 billion dollars while the amortization is about 4 billion dollars. This means the company is spending more money on expansion.

Looking at the last five years, EPS has increased at the rate of 9% per year. The return on assets has been somewhat lower at 8 and 9% respectively. The return on equity has been doing good at around 20%. The company gives away 25% of its earnings as dividends. The top line growth will probably be in the high single digits at around 8-9% per year with bottom line increases in low double digits - in the 10-12% per year for the next five years. This would mean EPS growth to about 4.7 dollars at the low end and 5.15 dollars at the higher end. A P/E of 15 would value the stock between $70 and $77 respectively. A return of about 40 - 45% over the next six years should be possible for this stock and especially fiscal 2008 should be good as the one time 800 million charge will not be in the books.

Investing in 2007 - comparing various asset classes

2007-01-13T07:19:00.000-08:00

In this segment, we will look at the P/E ratios of various asset classes we discussed in December. The data is updated at end of December, 2006 and the market movement since then has been more or less flat with slight positive/negative movement. We will look at each of the segments and see which ones are under/over valued.

First the large caps. The funds in this segment have been analyzed earlier.

Large Value:

IWW - has a P/E of 14.02 and expense ratio of 0.25%
VTV - has a P/E of 13.02 and an expense ratio of 0.11%
SDY - has a P/E of 16.35 and an expense ratio of 0.3%

Large Blend:

VV has a P/E of 15.31 and an earning yield of 1.67%. Expense ratio is 0.07%
IWV has a P/E of 16.37 and an earning yield of 1.43%. Expense ratio is 0.2%
VTI has a P/E of 15.47 and an earning yield of 1.64%. Expense ratio is 0.07%.

Large Growth:

IWZ has a P/E of 19.68 and an earning yield of 0.83%. The expense ratio is 0.25%.
VUG has a P/E of 18.91 and an earning yield of .91%. The expense ratio is 0.11%.

Next the mid cap segment.

Midcap Value:

IWS has a P/E of 15.75 and an earning yield of 1.83%. The expense ratio is 0.25%.
EMV has a P/E of 15.56 and an earning yield of 2.12%. The expense ratio is 0.26%.

Midcap Blend:

IWR has a P/E of 17.97 and an earning yield of 1.31%. The expense ratio is 0.2%
VO had a P/E of 19.3% and an yield of 1.2%. The expense ratio is 0.13%.

Midcap Growth:

IWP has a P/E of 20.47 and an earning yield of 0.7%. The expense ratio is 0.25%.
EMG has a P/E of 19.11 and an earning yield of 0.52%. The expense ratio is 0.26%.

Smallcap Value:

IWN has a P/E of 17 and an earning yield of 1.59%. The expense ratio is 0.25%
VBR has a P/E of 14.66 and an earning yield of 1.93%. The expense ratio is 0.12%.

Smallcap Blend:

VB has a P/E of 16.62 and an earning yield of 1.23%. The expense ratio is 0.1%.
IWM has a P/E of 18.83 and an earning yield of 1.07%. The expense ratio is 0.2%.

Smallcap Growth:

VBK has a P/E of 19.67 and an earning yield of 0.41%. The expense ratio is 0.12%.
IWO has a P/E of 21.56 and an earning yield of 0.32%. The expense ratio is 0.25%.

International ETFs:

Of the international ETFs, the interesting ones are noted below:

EEM has a P/E of 14.84 and an earning yield of 1.38%. The expense ratio is 0.77%.
VWO has a P/E of 12.62 and an earning yield of 1.75%. The expense ratio is 0.3%.

EFV has a P/E of 13.25 and an earning yield of 1.67%. The expense ratio is 0.4%.

Looking at all the asset classes, it is clear that large value, large international value, the emerging market ETFs offer the best deals for the new year.

Infosys (INFY) Analysis

2007-01-06T13:56:00.000-08:00

We looked at Infosys almost a year back. Since then, the stock has gained about 50% and has been added to the Nasdaq 100. Let us look at Infosys now and see how things look like for the next year.

Infosys (INFY) is a Indian multinational specializing in software services and off shoring. It is a top Indian company with a market cap of 30 billion. In this segment, we will look at the company and its financials. The overview of the company is as follows:

Infosys Technologies Limited (Infosys) has branches in China, Australia as well as in the U.S. The company provides services for every aspect of software development lifecycle from design and implementation as well as maintenance.

The revenue mix for Infosys for the first six months of 2006 is as follows. US contributed 64% to the revenues, Europe contributed 26% and India contributed 1.6%. Rest of the world contributed 8.7% to the revenue mix. This compares to 2005 mix of 64.6% for US, Europe 23.6%, India 1.9%, rest of the world 9%.

Infosys's net income increased 43% year over year and the share price has jumped by more than 50%. Our estimate of the revenue growth has been soundly been trounced - the strong revenue growth shows the continued strength in the outsourcing business.

The Infosys stock price has grown strongly on the back of strong Indian equity market. The stock price is a bit rich for ones taste at the moment and one can expect more sedate returns from the stock in 2007.

Domestic vs International large value funds

2007-01-01T15:07:00.001-08:00

Happy new year to all the readers of this blog. We looked in detail the different investment segments and their valuation in a series of articles in December. In this article, we will compare and contrast the domestic and international value funds to see which one is a better bet for the current year.

Primarily, we will look at VTV, the vanguard large cap value fund and EFV, the iShares MSCI EAFE value fund.

The top ten holdings in VTV are

XOM - Exon Mobil Corp has a P/E of 12
GE - General Electric Company has a P/E of 22
C - Citigroup Inc has a P/E of 11.4
BAC - Bank of America has a P/E of 12.2
PSE - Pfizer Inc has a P/E of 14.8
MO - Altria Group has a P/E of 12
JPM - JP Morgan and Chase has a P/E of 13.6
CVX - Chevron has a P/E of 9.6
AIG - American International Group has a P/E of 17.11
T - AT&T has a P/E of 19.4

The top holdings in EFV are:

HBC - HSBC Holdings PLC. The analysts seem to say there is some upside to this stock still.
TM - Toyota Motor Corp has a P/E of 15 and a market cap of 203 billionNestle
SA - no data is available.
VOD - Vodafone Group PLC has a market cap of 162 billion
RDS-A - Royal Dutch Shell PLC-Class A is selling for a P/E of about 10
Royal Bank of Scotland Group PLC - no good data available
STD, Banco Santander Central Hispano SA has a P/E of 12 and market cap of 116.5 billion
RDS-B - Royal Dutch Shell PLC-Class B is also selling for a P/E of about 10 and market cap of 230 billion
BNP Paribas - no good data available
BCS, Barclays PLC has a P/E of 13 and a market cap of 92 billion.

On doing a stock by stock comparison, the US equities inVTV seem a lot better with better ROE when compared to their EFV counterparts. The US equities also have lower P/E ratios and better earning growth prospects because of their better return on equity.

Interestingly enough, the US companies derive a good percentage of their revenues outside the US. So a weakening dollar should translate to better than expected earnings. The EFV stocks should benefit more from a weakening dollar if majority of their business is outside the US.

The comparison between these two in the past three months can be found below:
three month chart

The difference is starker when looking at the results in the last one year:
one year chart

Overall, the large value segment still looks attractive. Buying this asset class during dips in value should prove to be a good investment strategy for 2007.

Investing in 2007 - summary

2006-12-21T18:02:00.000-08:00

In this series, we started off by examining the returns in 2006 through various asset categories. The asset categories included REITs, small caps, mid caps, large caps, foreign stocks and commodities. We then analyzed the P/E and valuations of different asset categories. We found REITs to be overpriced and we also found the outlook for commodities a bit weaker going into the new year. In the other asset categories, we found many asset categories to be richly valued because of the broad bull market in the second half of 2006.

Our analysis didnt include individual stocks. Despite the broad bull market, it is possible to find a few companies trading below intrinsic value. Such a find requires careful study and deep analysis. We will be analyzing some companies individually in this blog from time to time.

The analysis of the macro economic trends indicates a strong year for the emerging markets and a decent year for the developed economies especially the ones in the Euro zone. All in all, the future looks bright with a few road bumps along the way.

We conclude this series of investing in 2007 by wishing the readers a happy holiday season and a prosperous investing new year.

Investing in 2007 - commodities

2006-12-21T04:03:00.000-08:00

In the previous article, we looked at the foreign stocks from both the developed world as well as the emerging markets. In this section, we will touch upon commodities - a topic we briefly looked at in the first article of this series.

Let us start with gold. The year over year gold consumption has fallen by 3%. While the usage of gold for industrial use has increased, its use for retail and investment purposes has declined. The high prices typically reduce consumption and this has been the case with gold. The industrial use of gold will increase as the global growth increases but the retail/investment sectors are difficult to predict. Another 20% rise in gold prices most likely will dent the retail usage further.

Silver has had a comparatively weak year thus far this year after a runup. This indicates the supply is meeting or exceeding demand already. The creation of the silver ETF generated a lot of enthusiasm for the metal. The main silver production comes from mining, government selling and from scrap. The main consumers of the metal are industrial usage, photography, jewelry and coins.

The other key industrial metal, copper has also declined in value from its highs earlier in the year.

The other common commodity is coffee. Its price has also increased by about 20% from the previous year. Coffee has been very cyclical - increase in prices causes higher growth and decline in prices causes some of the smaller farmers to go bankrupt. Sustained increase in prices will result in higher production and consequently lower prices for this commodity.

Orange juice and pork bellies have also increased in price. Some of this has to do with higher inflation and the devastating hurricane seasons of the prior years. It remains to be seen if these higher price levels can be sustained in the next year.

Finally, the mother of all commodities, oil is expected to remain flat to lower in the next three years. This considers that the current situation in the middle east wont deteriorate further and increase in gas prices will curtail consumption. Oil has cyclical effect on the economy and other commodities as energy is the least common denominator in modern civilization.

Overall, the outlook for commodities doesnt look bullish for the new year. However, disruption to oil supply, further decline in the dollar or other unforeseen events can move the prices higher.

Investing in 2007 - foreign stocks

2006-12-19T00:09:00.000-08:00

In the last article of this series, we looked at midcap stocks and their returns and P/E ratios. In this section, we will look at some foreign ETFs and their current P/Es and valuations. As noted in the second article in this series, the foreign ETFs of interest are the iShares EFV, EFG, EFA. We also have the vanguard funds VGK and VPL. In addition, we have the emerging market funds EEM and VWO. We will look at each of these in detail in this section.

First, let us look at the top holdings in EFV, EFG and EFA respectively. We will start with EFV.

EFV - the top holdings for EFV are:

HBC - HSBC Holdings PLC. The analysts seem to say there is some upside to this stock still.
TM - Toyota Motor Corp has a P/E of 15 and a market cap of 203 billion
Nestle SA - no data is available.
VOD - Vodafone Group PLC has a market cap of 162 billion
RDS-A - Royal Dutch Shell PLC-Class A is selling for a P/E of about 10
Royal Bank of Scotland Group PLC - no good data available
STD, Banco Santander Central Hispano SA has a P/E of 12 and market cap of 116.5 billion
RDS-B - Royal Dutch Shell PLC-Class B is also selling for a P/E of about 10 and market cap of 230 billion
BNP Paribas - no good data available
BCS, Barclays PLC has a P/E of 13 and a market cap of 92 billion.

Overall, this ETF has done better than the ING International Value Fund - NIIVX since inception and carries a lower expense ratio. The stocks in this portfolio are similar to that in VTV except that a declining dollar would make this ETF do better. EFV has returned about 25% so far this year. This ETF has exposure to Europe, Japan and Australia. Exposure to Europe is about 70% ( Great Britain at 25% ) followed by Japan ( 22% ) and Australia ( 6% ).

EFA is the blend that has the growth and value stocks in the mix. EFA has the following companies in its top 10 holdings.

BP PLC
HSBC Holdings PLC
Toyota Motor Corp.
Total SA
GlaxoSmithKline PLC
Vodafone Group PLC
Nestle SA
Royal Dutch Shell PLC-Class A
Novartis AG
Roche Holding AG

This portfolio includes oil, banking, technology companies and drug majors. This is overall a good mix. EFA has returned 24% thus far this year. This stock has exposure to Europe, Japan and Australia. Exposure to Europe is about 70% ( Great Britain at 24% ) followed by Japan ( 22% ) and Australia ( 5% ).

EFG is the growth counterpart of the above family. The top holdings of this segments include:

BP
GlaxoSmithKline
Novartis
Roche Holding
Mitsubishi UFJ Financial Grp
Total SA
Sanofi-Synthelabo
AstraZeneca
Siemens
BBVA

This ETF has returned 18.5% thus far this year. The geographic exposure of this fund is Europe, Australia and Japan. In Europe, it has exposure to Great Britain is the highest around 23%.

The Vanguard European ETF, VGK has returned 32% YTD. VGK has heavy exposure (~30%) to Great Britain market. The Vanguard Pacific ETF VPL has returned about 10% thus far this year. VPL has heavy (~70%) exposure to Japan.

Summary: The main thing to note here is that the above ETFs reflect developed country markets with focus on large stable companies. Some of these companies have significant operations in the U.S. The markets in the developed countries are not overvalued but cant be said to be undervalued either. It is prudent to wait for a market downturn before adding further capital to these ETFs.

Let us look at the emerging markets - the main ETFs here are VWO and EEM.

VWO:
The country wise distribution of holdings is - Korea (18.5%), Taiwan (15.8%), Hongkong (10.64%), South Africa (10.4%), Brazil (8.3%), India (7%) and Mexico ( 6.69%). This ETF has 771 holdings altogether. The top holdings in this ETF are:

Samsung Electronics
Taiwan Semiconductor Mfg.
China Mobile
Petroleo Brasileiro Sa Petrobras
America Movil S.A. de C.V
Kookmin Bank
Sasol Ltd
Petroleo Brasileiro Sa Petrobras
Teva Pharmaceutical Industries Ltd
PetroChina

EEM:

The geographic distribution of the holdings are South Korea (15.64%), Taiwan (10.99%), Brazil (10.43%), Hongkong (9.95%), South Africa (9.73%), Mexico (7%), India (6%) and Russia (5%).

Gazprom OAO (ADR)
Samsung Electnc GDR 144A
Taiwan Semiconductor Manufacturing ADR
Posco ADR
Kookmin Bank ADR
Lukoil ADR
United Microelectronics Corporation ADR
Siliconware Precision Industries Co, Ltd. ADR
Chunghwa Telecom Company, Ltd. ADR
Korea Electric Power ADR

Summary: EEM has outperformed VWO of late inspite of the higher expense ratio. The emerging markets in India, China, Brazil and Mexico have all done extremely well in the past two years and may be ready for a correction. The correction can be significant - in the range of 10-20%. It may be time to pick up more of either of these ETFs decline significantly.

Investing in 2007, mid caps

2006-12-17T18:36:00.000-08:00

In the last section, we looked at the small cap category and examined the growth, blend and value segments. In this category, we will look at midcap ETFs. As noted earlier, this analysis looks at the sector as a whole and doesnt look at individual stocks. It is always possible to have a mispriced stock within each category.

In the past segments, we looked at vanguard ETFs for our analysis. Since there isnt any comparable vanguard funds in the midcap section, we will look at the iShares section instead. By definition, a midcap stock is a stock with valuation between 1 and 5 billion.

Midcap value:
IWS is the ETF we will analyze for this article. As noted in the first article of this segment, this ETF has notched about 20% return already this year. The top holdings of this segment are as follows:

ETR, Entergy Corp has a P/E of 20.5 and a market cap of 19 billion.
EOP, Equity Office Properties Trust has a large P/E and a market cap of 16.9 billion.
AEP, American Electric Power Co., Inc has a P/E of 24.8 and a market cap of 16.67 billion
PCG, PG&E Corp. has a P/E of 17.48 and a market cap of 16.52 billion
XRX, Xerox Corp. has a P/E of 13.48 and a market cap of 16.44 billion
PLD, Prologis REIT has a P/E of 24.75 and a market cap of 15.13 billion
EQR, Equity Residential REIT has a P/E of 18.97 and a market cap of 15 billion
VNO, Vornado Realty Trust REIT has a P/E of 36 and a market cap of 17.47 billion
EIX, Edison International has a P/E of 12.84 and a market cap of 14.69 billion
F, Ford Motor Co. has a market cap of 13 billion

Midcap blend:
IWR is the ETF in this segment. This ETF has notched about 16.5% return already this year. The top holdings of this segment are as follows:

HD, Harley-Davidson, Inc. has a P/E of 18 and a market cap of 18 billion
CELG, Celgene Corp. has a P/E of 400 and a market cap of 21 billion
ETR, y Corp.
JCP, JC Penney Co., Inc. has a P/E of 15 and a market cap of 17 billion
Thermo Electron Corp.
EOP, Equity Office Properties Trust has a large P/E and a market cap of 16.9 billion.
AGN, Allergan, Inc. has a market cap of 18.5 billion
ERTS, Electronic Arts, Inc. has a market cap of 16.3 billion and a P/E of 90.
YUM, Yum! Brands, Inc. has a P/E of 20.29 and a market cap of 15.51 billion.
COH, Coach, Inc. has a P/E of 30.7 and a market cap of 15.45 billion

Midcap growth:
IWP is the ETF in the midcap growth segment. This ETF has returned about 13% this year. The top holdings in this group are as follows.

HD, Harley-Davidson, Inc. has a P/E of 18 and a market cap of 18 billion
CELG, Celgene Corp. has a P/E of 400 and a market cap of 21 billion
JCP, JC Penney Co., Inc. has a P/E of 15 and a market cap of 17 billion
AGN, Allergan, Inc. has a market cap of 18.5 billion
ERTS, Electronic Arts, Inc. has a market cap of 16.3 billion and a P/E of 90.
YUM, Yum! Brands, Inc. has a P/E of 20.29 and a market cap of 15.51 billion.
COH, Coach, Inc. has a P/E of 30.7 and a market cap of 15.45 billion
AMT, American Tower Corp.-Class A has a market cap of 15.6 billion
FRX, Forest Laboratories, Inc has a P/E of 23 and a market cap of 16.15 billion
AES, AES Corp. has a P/E of 42 and a market cap of 14.9 billion

Summary:

The advantage of midcaps is that one gets a larger concentration of stocks that have good capitalization. If one has both large cap and small caps, a concentration of mid caps will be in the portfolio but to a far lesser extent.

Again, as we have seen in the other segments, the value segment has managed to outperform the blend and the growth segments. Overall, the value segment carries a lower P/E and P/B compared to the other segments.

Next article:

In the next article, we will look at international stocks and the prospects for them.

Investing in 2007 - part VI

2006-12-15T20:23:00.000-08:00

In the last article, we looked at investing in 2007 with large cap value and blend ETFs. Prior to that, we looked at REITs and the large cap growth sector. We found that REITs to be unattractive at current prices while large cap value and blend to be comparitively more attractive.

In this segment, we will look at small cap ETFs. Again, we will use the vanguard funds as examples where they are available. If not vanguard, a similar study can be done on other funds. It is the author's belief that the investors should look at the overall valuation of a fund/ETF along with expense ratios.

The small cap value ETF VBR has 953 stocks in the ETF. As of 11/30/2006, the ETF had a P/E of 18.9, Price to book ratio of 1.9. The return on equity is 10.7% and the earnings growth rate is 10.4%. The ETF had a yield of 2%. The top stocks in this ETF are as follows:

NU, Northeast Utilities has a P/E of 38
RA, Reckson Associates Realty Corp has a P/E of 28.29
SRP, Sierra Pacific Resources has a P/E of 12.82
CMS, CMS Energy Corp has a P/E of 15.
OGE, OGE Energy Corp has a P/E of 12.
OMX, OfficeMax, Inc has a forward P/E of about 20.
CLI, Mack-Cali Realty Corp. REIT has a P/E of about 36.
CVG, Convergys Corp has a P/E of 23.59
BRE, BRE Properties Inc. Class A REIT has a P/E of 31.55
CMC, Commercial Metals Co has a P/E of 9.94

VB is the small cap blend and has a yield of 1.2% which is much lesser than the SP500 yield of 1.76%. As of 11/30/2006, the small blend stocks as a whole had a P/E of 22.6, with a price to book ratio of 2.4, ROE of 11.7% and earnings growth of 15.7%. The top holdings in this sector are:

NU, Northeast Utilities with a P/E of 38
RRC, Range Resources Corp has a P/E of 20.38
RA, Reckson Associates Realty Corp. REIT has a P/E 12.82
RMD, ResMed Inc has a P/E of 39.67
MTW, The Manitowoc Co., Inc has a P/E of 26.35
FWLT, Foster Wheeler Ltd has a P/E of 58.37
CAL, Continental Airlines, Inc. Class B has a P/E of 13.4
SRP, Sierra Pacific Resources has a P/E of 12.82
PXP, Plains Exploration & Production Co has a P/E of 13.59
CMS, CMS Energy Corp has a P/E of 9.94

VBK is Vanguard's small growth stock. It has an yield of .37%. As of 11/30/2007, this group as a whole had a P/E of 28, price to book ratio of 3.5, ROE of 13% and earnings growth of 23%. The top holdings of this group are:

RRC, Range Resources Corp. has a P/E of 20.38
RMD, ResMed Inc has a P/E of 39.67
MTW, The Manitowoc Co., Inc has a P/E of 26.35
FWLT, Foster Wheeler Ltd has a P/E of 58.37
GPN, Global Payments Inc has a P/E of 28.51
GME, GameStop Corp. Class A has a P/E of 39.17
DNR, Denbury Resources, Inc has a P/E of 18
CCK, Crown Holdings, Inc is expected to be profitable next year
AME, Ametek, Inc has a P/E of 19.35
FTO, Frontier Oil Corp has a P/E of 9.4

Summary:

In the small cap category, the top ten holdings constitute about 4% of the portfolio. So, they arent indicative of the entire sector. In looking at small value, small blend and small growth, the small growth category is looking pricy and there is little margin of safety in this segment. While small blend is looking better than small growth, it is not as attractive as the small value category. The small cap value stocks are a bit cheaper and are fully valued at the moment. Market price drops may provide an opportunity to add more small value to one's portfolio.

Next Article:

In the next article, we will look at mid cap segment. We will also evalutate the midcap segment with respect to the large cap and small cap segments.

Investing in 2007 - part V

2006-12-15T05:44:00.000-08:00

In the previous article, we looked at REITs and large cap growth segments. We found the REITs to be somewhat overpriced compared to the earning yield and P/E ratios. The large cap growth segment has some potential to do well in 2007.

In this article, we will look at two other segments, large cap value and large cap blend categories. Again, we will use Vanguard funds as the examples as we have more information about the funds and vanguard funds are one of the most widely held funds.

As noted in the first part of this series, the two vanguard funds in the value and blend category are VTV and VV respectively.

The outlook for VTV is as follows. As of 11/30/2006, VTV had a P/E of 14.2 with a price to book ratio of 2.2, ROE of 18.2% and growth rate of 16%. The growth rate denotes the earnings growth for the past five years. The ETF had about 400 stocks in its core holdings. The top holdings of this group are as follows.

XOM - Exon Mobil Corp has a P/E of 12
GE - General Electric Company has a P/E of 22
C - Citigroup Inc has a P/E of 11.4
BAC - Bank of America has a P/E of 12.2
PSE - Pfizer Inc has a P/E of 14.8
MO - Altria Group has a P/E of 12
JPM - JP Morgan and Chase has a P/E of 13.6
CVX - Chevron has a P/E of 9.6
AIG - American International Group has a P/E of 17.11
T - AT&T has a P/E of 19.4

The top ten holdings accounted for ~30% of the funds portfolio. This sector looks good and can potentially rake in decent returns in 2007. The energy sector is a wild card but the share holder friendly moves by cash rich management should help.

The profile of VV is as follows. This fund holds about 790 stocks. As of 11/30/2006, this fund had a median market cap of 45.6 billion, P/E of 17.1, Price to book ratio of 2.9, ROE of 18.7% and earning growth rate of 19.1%. The earnings growth rate denotes the growth rate for the past five years. Let us look at the top holdings in the ETF as these comprise 18.2% of total net assets.

XOM Exon Mobil has a P/E 12 and market cap of 450 billion
GE General Electric has a P/E of 22 and a market cap of 385 billion
MSFT Microsoft has a P/E of 24 and a market cap of 295 billion
C Citibank has a P/E of 11.6 and a market cap of 265 billion
BAC Bank of America has a P/E of 12 and a market cap of 235 billion
PFE Pfizer has a P/E of 14.88 and a market cap of 184.88 billion
PG Proctor and Gamble has a P/E of 23.8 and a market cap of 203 billion
JNJ Johnson and Johnson has P/E of 17 and a market cap of 192 billion
MO Altria Group has a P/E of 15.78 and a market cap of 178.6 billion
CSCO Cisco has a P/E of 29 and a market cap of 167 billion

In the value category to the blend category and their top ten holdings, both have some of the same stocks. The interest is in the differences, the blend has Microsoft, JNJ and Cisco and other stocks in different composition levels. Microsoft is expected to do well in 2007 as is JNJ. Cisco is on a tear currently and may not be considered as cheap. The value segment has Chevron, JP Morgan and AT&T. The telecom sector has been hot this year and both oil and banking have had record years. This performance may be hard to beat in 2007.

Summary:

I like the value and blend segments to the growth ETF we discussed in the earlier article. The growth ETF has more potential but is also priced higher. Again, the time to buy these securities is when the market is down and when the valuations are more attractive. Currently the market is going up, a situation that may not reverse itself till well into the new year.

Next article:

In the next article in this series, we will look at the domestic small cap segment and go into the details of that sector.

Investing in 2007 - part IV

2006-12-15T00:49:00.000-08:00

In the previous articles, we looked at the different asset categories and the returns from these asset categories in 2006. The return from asset categories in 2006 is important as the current prices will tell us if the asset is a buy at current prices or not. In this section, we will look at the REITs and the large cap growth sector in US to see if they are buys at current prices. The analysis in this segment is limited to the sector as a whole as opposed to individual stocks. It is possible for the sector to be expensive and thus unattractive. At the same time, a stock in this category might be a buy because of the fundamentals.

First the vanguard REIT etf VNQ. The current yield for VNQ is 3.63%. Given that the REITs are required to return 90% of their income to the shareholders, the effective yield is 4%. The ten year bond is currently yielding 4.6% and is entirely safe. So, the REITs aren't looking attractive at the moment. Let us look at some more details to see how VNQ looks like.

As of 11/30/06, VNQ's equity characteristics were as follows. The P/E ratio was 49 with return on equity of 8% and projected earnings growth of -3.6%. The REIT ETF held 104 stocks altogether. Let us look how some of the top holdings for this ETF looks like:

SPG - Simon Property Group has a P/E of 59.
EOP - Equity Office Properties has a P/E of 40.
VNO - Vornado Realty Trust has a P/E of 37.
PLD - ProLogis has a P/E of 25.
EQR - Equity Residential has a P/E of 19.
ASN - Archstone Smith Trust has a P/E of 17.
BXP - Boston Properties has a P/E of 16.
PSA - Public Storage has a P/E of 67.
GGP - General Growth Properties has a P/E of 229.

As a group, the above equities have high P/Es and the stocks with lower P/Es have low dividend yields. Looking at the fundamentals of this sector, it is safe to stay away from this sector at this moment till the P/E and the dividend yield become more reasonable.

Looking at the large cap growth sector, let us take a look at VUG, the vanguard growth ETF. The growth ETF equities have the following characteristics as of 11/30/2006.

The ETF held 457 stocks altogether with a median market cap of 34.8 billion. The P/E of the ETF is 21.5 with a price to book ratio of 4 and earnings growth rate of 23.1%. The return on equity is 19.1% which is very respectable. Let us look at the top ten holdings from this ETF and their P/E ratios and growth prospects. The ten largest positions account for 21% of the ETF holdings.

MSFT - Microsoft Corporation has a P/E of 24.
PG - Proctor and Gamble has a P/E of 24.
JNJ - Johnson and Johnson has a P/E of 17.4
CSCO - Cisco Systems has a P/E of 27.
INTC - Intel Corpoation has a P/E of 21.
WMT - Walmart Stores has a P/E of 17.
GOOG - Google Inc has a P/E of 61.
PEP - Pepsi Inc has a P/E of 21.
IBM - International Business Machines has a P/E of 16.
AMGN - Amgen Inc has a P/E of 29.

As a group, the top ten holdings of this group are mixed. On the one hand there are fully priced stocks such as Google and on the other hand, there are low priced stocks such as WMT and JNJ with a bunch of stocks in between. It should also be noted that as a group, this sector is entirely dependent on growth to power the stock price. My bet for this group would be to do decently in 2007. The main reason being the top holdings of MSFT and INTC are expected to do well on the back of new product launches, CSCO is doing ok and the some of the low priced stocks may succeed in getting out of the negative publicity surrounding them. It is not possible to find the right time to get in but I would get in once the major indices have a correction from the current price points.

In the next segment, we will cover the large cap blend and value segments.