October Was Quite A Surpise!

10/31/06 October Was Quite A Surprise.

The general consensus about the stock market and I admit I shared this view at the end of August was we were in for a tough September and October. What that view ignored was the damage the market had suffered from May thru August and the fact that the Fed finally paused. The bottom line was the only thing that had been holding this market back for the last year was the overhang of the Fed raising rates. Once it became clear they were out of the way, boom, this market was off to the races.

On September 4th I reversed myself and turned bullish and went 200% long the market with Proshares Ultra exchange traded funds. I remained bullish for almost two straight months and just turned short-term cautious last Wednesday. We have had one of the best runs in the market in years as the bears just got run over. It took months to draw the skeptics back into the market and now the individual investor has returned somewhat. The only problem is now that individual stocks at low valuations are hard to find.

The model portfolio's performance kicked in during October and rose about 6.86% for the month. That beat the large cap major market indexes by a mile as the Dow rose 3.2%, S+P 500 was up 2.94% and the Nasdaq which rose 4.7%. The broad market indexes like the Russell 2000 was up 5.6% and the S+P mid-cap 400 was up 3.84%. The majority of my performance came from the Proshares Ultra (DDM,SSO,MVV), Game Stop (GME) and the IPO Scientific Applications International (SAI). That is one reason it is hard to market time in a normal market. You will get caught not fully invested when the market makes its big move for the year.

Last year I had a 72% / 28% win loss ratio for my recommended trades and an average 4.1% gain per trade. This year I have recommended 260 individual trades (that includes a lot of 5% only trades) and so far in 2006 60% (156) have been winners while 40% (104) have been losers for an average gain of only .072% per trade. I'm trying to get my win loss ratio higher and my average gain per trade up but those are pretty much dictated by market action. My average holding period during the first half of the year was one week which I'm also working on extending that. At these rates the commissions and taxes start to take a bigger percentage of our gains but even after those are factored in my picks still beat the market indexes.

So far now in the market the easy money has been made for a while. We need to go back to being patient and giving our stocks some time to work as long as they don't go south based on a fundamental reason.

Why I like Federated Investors?

Federated Investors (FII) is a asset management firm with over $210 billion in assets under management. They have about 50% of assets under management in stocks and bonds and about 50% in money market funds. That's is why they are given a lower valuation relative to its peers because money market funds are less lucrative. However the valuation gap with this stock is so large relative to its peers that it is a lower-risk stock with great upside. It trades at about 19.5 times earnings versus its peers that trade at 24-27 PE for its competitors. The stocks trades at 3.75 times enterprise value divided by revenue versus 5-6 for competitors. The stock also has a 2.05% dividend and will go ex-dividend around Nov. 4th. If this company's valuation remains this low, it could be an attractive private equity takeover worth about $42 and on its fundamentals alone is worth about $39.

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SAIC IPO

10/12/06 Raising Cash for SAIC IPO.

The market has been really good to us now for about a month. Today the market snapped back after the disappointing earnings reports yesterday. The earnings reports today were better and stocks continue to attract institutional and individual investor money. One thing I think is interesting in that mutual fund inflows have remained negative while the market has been soaring. That along with the fact that the Citigroup Euphoria/Panic model is not even close to euphoria level, says this market will probably continue to do well for a while. At the market peak in May it was beyond euphoric levels which was a warnings of an imminent correction. You can find the model every weekend in the market watch section of Barron's, which I recommend you subscribe to and read every week so you can get into the mind set of fund managers who all read it. However with the Dow approaching a large round number that it has never achieved before (12,000), I feel like it is time to take some profits. I want to raise some cash to lock in some profits, diversify more and for an IPO likely to debut tomorrow that I think is attractive.

The IPO tomorrow is Science Applications International Corporation (SAI-NYSE). It is an employee owned defense contractor based in San Diego, Ca. that is thirty seven years old and has $8 billion in revenue. They get 85% of their revenue from federal government contracts and have some key long-term defense contracts. Unfortunately, Jim Cramer told his viewers about this one on Monday and said he thinks the stock could go to $20-25. Defense contractors trade at 1-1.44 times revenue but this one deserves at least that valuation because they don't have big risky weapons projects that require billions in investments. The expected range is $13-15 but I expect that will be upped to $17-18 when they announce the final IPO price tonight. They have $8 billion in revenue so a price of $21 equals 1.12 times enterprise value divided by revenue. I will put my order to buy at a limit of $21.12. Always use a limit if trying to buy an IPO because the stock could open anywhere on the secondary market trading. If I get the stock at $21 or less, I think it could trade at $24-25 in 3-6 months. Whenever you buy a highly desired IPO there is a risk you get the first print and then it immediately goes down but on this one I'm willing to try to get it on the first print because there should be good institutional demand for the stock even in the secondary trading.

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Wal-Mart: Bargain Or Short Sale Candidate.

Wal-Mart: Bargain Or Short Sale Candidate.

I hear many analysts and value oriented fund mangers saying what a bargain Wal-Mart (WMT-NYSE) is at these levels. I have followed Wal-mart since 1996 and from 1996-2000 it was one of my favorite steady growth stocks. However it got caught up in the large-cap growth mania in late 1999. The stock then became wildly overvalued at over thirty-five times earnings. Since 2000 the stock has slumped and has gone flat now for almost seven years and continues to trap value investors.

For the last eighteen months many value investors with good track records have continued recommending Wal-mart. Unfortunately, they have been sorely disappointed and are ignoring the basic fundamental problems of the company. Supporters of the stock say the company has added $140 billion in revenue and doubled its net income in that time period, while the stock price is actually down significantly which is true. However that rationale ignores its fundamental overvaluation then (it was 59 times earnings then) and its deteriorating fundamentals currently. Not only is Wal-mart not a bargain here at $48, the stock is a better short than a long.

Lets look at some facts about Wal-mart’s core business:

• Domestic same-store sales growth in 2006 has averaged only up 2.5%. I have noticed over the years that the key to Wal-Mart’s stock performance is when they grow same store sales at 5% plus, they usually consistently grow their earnings at 15% plus. This same-store sales growth is essential to leverage their expenses and pay for their growth in order to produce steady revenue and net income growth. Until they turn this trend in comparable-store-sales around and have two back-to-back months in excess of 5% growth, you should avoid being long the stock. I suspect the reason this number has been so low is for the last two years is an overly aggressive expansion of new domestic stores is cannibalizing existing stores. That is good for top line revenue growth but increases expenses and hurts net income.

• Many value investors claim you are only paying a slight premium for Wal-Mart compared to the PE multiple on the S+P 500. The problem with that argument is they are ignoring the recent below average earnings history of the company. While the S+P 500 trades at about 16 times 2006 earnings versus Wal-mart which currently trades at about 16.5 times 2006 earnings estimates of $2.89 for 2006. The problem is Wal-mart’s earnings aren’t growing at 15% anymore. They have been growing at only 7% last quarter, 7.6% for this year and within the last twelve months Wal-mart reported its first actual profit drop in decades. So in reality, right now you are paying almost twice the growth rate of the S+P 500 for a below average retailer with little organic growth.

• CEO Lee Scott has about used up his list of excuses and is strating to lose credibility with Wall Street. Wal-Mart has blamed gasoline prices were hitting its lower income customer disproportionately for almost two years now. That excuse fooled many but when gasoline fell 25% in September their same-store sales were still up only 1.3%. Then they blamed the weather and said hurricane preparation in 2005 made their September comparables challenging. In fact Wal-mart just can’t admit they are losing market share to their competitors and are loathe to admit that they don’t have a strategy that is working.

I think Wal-mart is a good short candidate here at $48 because the stock has rallied with other retailers yet doesn’t have the fundamentals to justify the higher stock price. Of course there are some risks to a short position in the stock. I would cover my position if they reported two consecutive months of same-store sales growth in excess of 5% or if a new CEO was announced. I would stop my loss if the stock went above its 52-week high of $51. I think the stock could trade back down to $43, which is my target. So the stock as a short position has $5 in potential reward for $3 in potential downside, which equals a 1.66 to 1 reward to risk ratio. Because in my newsletter service I don’t recommend short sales, I have no position currently in the stock.

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Taking Profits on Proshares Ultra.

10/5/06 Taking Profits on Proshares.

The hardest decision to make sometimes is when to sell a position, especially a winning position. You go back and forth about I have a winning position: why shouldn't I just let it run. Should I take profits on just a portion or the entire position? Are there better opportunities to invest elsewhere or do I want to remain in cash? The more the indexes have marched higher the more I have thought about when I'm going to take my profits on my Proshares positions. I think the time is right now to take profits on the index ETF's and buy individual stocks again. We have done well with the Proshares returning 4.9-5.8% in less than two weeks due to the big up move in the market.

I went up and down my watch list looking for individual stocks to buy and there is still some stocks with reasonable valuations. They are in the casino sector, financial, insurance, banking and a specialty retailer. I can't go into my rationale for buying each individual stock today but I will explain each buy in the near future. When you go to sell your Proshares use limit orders and try to get fills near the middle of the bid and ask spread if you have time, you can get an extra 5-10 cents.

If you would like more information about my newsletter service or the companies that I follow, please visit my Web site. (Link to http://www.valuestocktips.com/)