Undervalued Weekly
The Undervalued Reports Company’s weekly newsletter
Towson, MD
November 29, 2003
www.dynamicinvestors.net/memberhome.html
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Happy Thanksgiving!
I hope you had a wonderful holiday. I know I had a great time. There’s nothing better than enjoying two Thanksgiving dinners with two wonderful families. Little Josephine had a great time as well, playing with her grandparents, aunts, uncles, cousins and anyone else who may have come out of the woodwork. It seems now that we have a baby nobody even notices the wife and I. We’ve been relegated to the status of baby-chauffer, but I’m sure we’ll survive.
Before I get into the weekly news, I have to tell you about a little promotion I’m running. I’m offering the chance to win a free book every week, for at least 10 weeks, just for referring people to the Undervalued Weekly. If you’d like to earn a free book, click here to find out more.
It was a short week in the markets, with Thursday off and Friday short. But like any good drama, there was no lack of action. The Dow 30 rose 153.93 points (1.6%) to 9782.46. The S&P 500 was up 22.92 (2.2%) to close at 1058.20, and my good friends at the Nasdaq jumped 66.38 (3.5%) to end the week at 1960.26. But the stock market wasn’t the only place for action this week. At the close of business Friday, spot gold was trading at $398.10, up just $2.10 for the week. But this week again saw gold breaking the $400 mark. Gold has broken $400 twice in the last two weeks, intra-day, but can’t seem to close above. I think it’s only a matter of time.
Obviously, I’m not the only one who has concerns about the US money supply. Steve Forbes had some comments on money and gold as well this week. In his December 8, 2003 Fact and Comment section of Forbes, Steve devoted the top spot to a discussion of Federal Reserve monetary policy. Here’s some of what he has to say,
“The Federal Reserve is planting the seeds for future inflation. This at a time when we're just recovering from the inadvertent deflation the central bank caused, which began in the late 1990s and didn't end until last year. The Fed, in short, is printing too much money. We won't feel the full shock until after next year's elections. What we're about to undergo is equivalent to the situation of a patient who's been suffering from a below-normal temperature of 96 degrees and whose doctor decides to raise it to 102 so the patient's average would then be the normal 98.6. Alan Greenspan is guilty of monetary malpractice.”
He goes on to discuss the importance of the “psychological” $400 barrier…
“The average gold price for the past decade has been roughly $330. If the Fed was doing its job right, the price would be around $350 today. Investors should pay close attention to the yellow metal. If it breaches $400 an ounce and stays there, this new bull market will morph into an unpleasant bear by 2005.”
I’m just calling it like I see it and so, it seems, is Mr. Forbes.
As if on cue, the dollar fell to an all-time low against the Euro this week, driving treasury yields higher. The ten-year bond fell nearly 4%, raising the yield to 4.32% from last week’s 4.15% close. Thirty-year treasuries finished the week at 5.12%, up from 5.01%, a drop in price of about 2%. The dollar finished the week at 0.83 Euros, or the Euro finished at $1.20 today, whichever way you want to look at it.
Since January 2002, the Euro has gained 40% against the dollar, while at the same time gold has risen 43%. Coincidentally, the Fed began aggressively reducing rates, and pumping the money supply, in the year before they started their rise. Do you think there’s some connection?
It won’t be long before the Fed will have to raise interest rates or be faced with massive price inflation. The gold and currency markets are anticipating the latter, and I wouldn’t bet against them.
There was certainly some good economic news this week, however. Third-quarter GDP growth was revised upward to 8.2%, the best quarter in almost twenty years, and more than double the second quarter growth of 3.3%. In November, Consumer confidence hit its highest point in over a year, with the index rising to 91.7 and clobbering Wall Streets estimate of 85. After-tax corporate profits were up 10.6% in the third quarter, and non-residential business spending was up 14%. It looks like the monetary stimulus and cheap credit is working. How long it will last is anybody’s guess.
In a sign that the housing market may be cooling, new-home sales and existing-home sales were both off last week. New-home sales dipped 3.5% and existing-home sales dropped almost 5%. Rising rates might just prick this bubble next year.
In other news, Friday was the official start of the holiday shopping season. It’s expected to be the best one we’ve seen in a long time, thanks to a strong economy, rising consumer confidence, and tax cuts. Some economists wouldn’t be surprised to see this year’s sales jump by a double digit percentage. My gut tells me this will be a good year for holiday sales. Right now, consumer debt to disposable personal income is at the lowest it’s been in years, which means there’s more credit card juice out there than there’s been in a while. This will certainly encourage people to spend.
Yet even with the strong economy and lots of available credit, a survey conducted by the Consumer Federation of America and the Credit Union National Association indicates holiday spending may be down this year. Of the 1,017 adults surveyed, 34% said they planned to spend less this year, while only 15% said they planned to spend more. Those aren’t the answers you expect to see in a booming economy.
So what’s the right answer? I don’t think anyone knows for sure. Certainly not me.
Turning to the world of mutual funds, Putnam lost another $9 billion in capital this week as CalPERS (the California Public Employees Retirement System) and Wal Mart both pulled their retirees’ funds out of Putnam. Assets under management at Putnam have fallen by more than 10% in the last month. Now, if you’re like me, you might be looking at Putnam and its funds as a contrarian play, should they continue taking a beating. I try never to let my personal opinions get in the way of smart investing.
In a dramatic escalation of the mutual fund fight, the dynamic duo of federal regulators and Elliot Spitzer’s office brought fraud charges against Security Trust, a Phoenix-based firm that handles mutual fund trade orders, for assisting in the illegal late trading of mutual funds. The illegalities at the company were thought to be so bad that the feds forced the company to dissolve. The company is expected to stay on government life support until pensioners and retirees can find another company to handle the trades.
Turning to politics, the Senate this week passed a Medicaire bill that, conservatively, will cost around $400 billion over the next decade. In typical government fashion, it’s an ugly mess that’s going to cost more money in the future without doing any real good. The part of this bill getting the most attention is the prescription drug benefit for seniors. Not only do working people get to subsidize retirement for the wealthiest demographic in the country, but now we get to subsidize practically the entire cost of prescriptions for them too. It’s no wonder jobs are going overseas in droves.
That’s about it for this week. Enjoy your weekend, and don’t forget about the subscription promotion.
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Book Recommendation
If you thought the stock market bubble of the late 1990s was a unique event in history, think again. In Manias, Panics and Crashes, Charles P. Kindleberger takes us through the history of financial manias, starting with the Dutch Tulip Bulb frenzy of the 1630s and wrapping up at the height of the 1990s stock bubble. The analysis in this book is excellent, as Kindleberger dissects each mania, looking for the lessons we should learn.
Obviously, what people should learn and what they do learn are two different things. Hence the reason we have recurring financial bubbles.
In his forward to the book, Peter Bernstein (author of Against the Gods) had this to say…
“One never picks up a work by Charles Kindleberger without anticipating a feast of entertainment. But underneath the hilarious anecdotes, the elegant epigrams, and the graceful turns of phrase, Kindleberger is deadly serious. The manner in which human beings earn their livings is no laughing matter to him, especially when they attempt to do so at the expense of one another."
Keep this book in reach and it will keep you grounded when you’re tempted to throw money at investment manias. Read and re-read Manias, Panics and Crashes.
For more must-have books, check out the Dynamic Investors Required Reading.
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SWOT Analysis
A couple weeks ago, we started looking at how we can analyze a company’s competitive advantage. Using the Porter’s Five Forces Analysis we are able to determine the relative power of external forces on a company’s competitive position. We concluded that companies that don’t compete on price, whose industry has high barriers to entry, and whose products don’t face significant threat of replacement will have stronger competitive positions. We also concluded that the more power a company has over its customers and suppliers, the stronger its competitive advantage.
This week, we turn our focus internally to analyze the unique abilities (or inabilities) of the company. This we do through SWOT analysis.
What is SWOT analysis? SWOT stands for:
Strengths
Weaknesses
Opportunities
Threats
Analyzing these four factors gives you a better understanding of a company in order to make better investment decisions. A good SWOT analysis can take some time and effort, particularly trying to collect and sort the data. It’s a brainstorming exercise, so take your time. The more effort you put into SWOT (and all your analysis for that matter) the better you will understand the company. We’ll look at each factor in turn.
First, we look at the company’s strengths. What does the company do well? What makes it better than others? What does the company have, or do, that sets it apart from its competition?
These are important questions, and should include aspects of the company that made you consider it for investment in the first place. Look at branding, image, pricing power, size, market share, financial position (balance sheet strength), etc.
Strengths can be relative or absolute, but be sure you know the difference. For example, a small company may have the best brand in its industry, which would be a relative strength. However, it may also have one of the best-known brands in the world, which I consider an absolute strength. Anheuser-Busch is a good example of company with absolute strength, because its Budweiser brand is one of the most well-known in the world. And it certainly doesn’t hurt to have the best selling beer in the world either.
Here are some strengths to look for:
Now that you’ve determined how wonderful the company is, it’s time to look for the weaknesses. The same questions should be asked when looking for weaknesses. What does the company do poorly, or not so well? What are other companies doing better? What is keeping the company from greater success.
It’s important that you don’t gloss over this section. SWOT analysis is a brainstorming effort, so don’t discount anything that comes to mind. If you perceive a weakness, list it. The insignificant weakness you fail to list today could be the reason your investment turns out poorly next year.
Some weaknesses to look for:
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We shift our focus to external factors when we look at opportunities. Here we try to identify areas of business we think the company is looking to enter, or should be looking to enter. We also look for opportunities to gain market share from competitors, or grow the company’s market to new customers. Are there any strategic acquisitions the company might be interested in?
But there are more than just external opportunities. There are opportunities within a company that should be considered. Can the company combine product lines to increase sales? Maybe the company has duplicate costs that can be streamlined. Companies can always find ways to do things better.
It’s important to look at the opportunities the company itself sees. Most companies will make details about management’s vision of the future public, including opportunities they want to capitalize on. We should look at how management’s ideas compare to our own, and see where our analyses disagree.
Some opportunities to look for:
Finally, we need to consider threats to the company. Again, threats can be internal as well as external. In fact, I’ve found that internal threats usually come first, which opens the door to external threats. Therefore, it’s important to do a good threat analysis.
Internal threats aren’t usually classified as such, which I think is a mistake. Any internal problem is a threat to the company’s well-being and should be evaluated alongside the external threats. For example, a company that relies on developing innovative products, such as Microsoft or Intel, faces the threat of losing engineering talent every day. This is an internal threat that could easily pave the way for external threats.
Some of the areas for threat analysis include:
SWOT analysis is a brainstorming activity. It should be enlightening and possibly fun once you get the hang of it. I recommend doing a SWOT analysis and a Porter’s Five Forces analysis on every company you’ve identified for investment. This will help you consolidate all the information on the company, in a way that makes sense. Focus on the weaknesses and the threats when doing SWOT, because those are the things that will turn around and bite you after you make your investment. I’m not saying you should look only for the negatives, and ignore the company’s potential. But you should analyze the risks with as much, or more, scrutiny then the opportunities. Opportunities don’t always show up, but somehow risks always do.
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Quotes of the Week
“We must never be afraid to go too far, for success lies just beyond.”
-Marcel Proust
“Money itself won’t bring happiness, but it sure makes paying the bills easier.”
-Thomas J. Vilord
The Fab Five
We’ve all heard the bad stories about insider activities. But large insider ownership is really a good sign, particularly in small companies. When insiders own a majority of a company’s shares, their decisions tend to more closely reflect shareholder interests. Therefore, it’s positive for a stock when insider ownership is large. This week we’re looking at five really small companies (under $50 million in market cap) with high insider ownership, and positive earnings in the trailing twelve months.
Company Symbol Price
ILX Resorts Inc ILX $6.90
American PAC Bank AMPB $7.98
KMG Chemicals KMGB $3.85
Aero Systems Engineering AERS $3.21
Security Capital SCC $6.30
Remember to do your research on companies before investing. Small caps are notoriously unstable, and you really have to research the companies well. This screener is only a starting point, not the final decision.
Until next week my friends, happy investing. Don’t forget to forward this newsletter to a friend.
Sincerely,
Christopher M. Mallon
Have you checked out the Dynamic Investors Marketplace?
How about the Required Reading?
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