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1/16/2006 6:46:41 PM - Stock Market Musings...

I follow the business market pretty closely. I haven't invested in any stocks in years, but I nevertheless find it all very interesting.

I figured that I'd write a few words - just for fun - regarding what I'd be doing if I were actually still invested.

Here are some stocks, my personal recommendation, and my thoughts on them. I do not recommend that you use this information for investing purposes. If you want to beat the majority of other investors in the stock market, it's really quite simple: go buy an index fund that tracks something like the S&P 500 with the lowest fees you can find...anything with annual fees above 0.3% per year is overpriced.

Microsoft - $27.20 - BUY at $24 and below.
I've been recommending this since it was just over $24 in October, 2005. I think that their Xbox 360 is going to do better than the original. I don't think that they'll make much money on it when all is said and done - I just think that they'll lose less money than they have in the past. I think that Windows Vista will generate a lot of positive press and stock momentum as its arrival draws near. It's scheduled for the second half of this year, and you'll need to be into the stock well ahead of that if you want to catch the updraft. I would look to sell at $30-33. I do not consider this a long-term stock to hold, but I do think that it's going to rise 20-30% (from my target price) over the next 18 months or so and that - because of the fairly regular earnings stream from Windows and Office - it's well insulated from much of a drop in the short term.

Intel - $25.75 - SELL above $20.
Intel is a disaster. Ever since their x86 architecture was chosen for the first IBM PC they have been able to ride the growth in the PC market to fame and fortune. What always amazes me is that people somehow equate the growth of the PC market - and therefore Intel's fortunes - with Intel being a well-managed company.
Smart managers do not price their products such that competitors with a far higher cost structure can still significantly undercut them on price. That is exactly what Intel did with AMD for decades, and it allowed AMD to eventually grow into a far stronger competitor that today dramatically limits the profits that Intel can generate. Microsoft and Intel - Wintel - used to rule the PC marketplace together. If Microsoft had priced Windows as exorbitantly as Intel priced its CPUs - even the older ones that could be inexpensively produced - Apple would have a lot more than 3% market share.
If Intel was so well-managed, why didn't they have a competent strategy for migrating PCs to a 64-bit environment? After their Itanium flopped and AMD decided to add 64-bit extensions to the existing x86 architecture, Intel repeatedly swore that they'd never follow their lead...and then wound up doing exactly that.
That was a monumental milestone in computing history. Intel - the original x86 architect and the wildly dominant supplier of the technology for decades - was resorting to copying AMD's CPU features. The irony of this is simply staggering and not what you would expect from a "well-managed" company.
I could go on and on about Intel's missteps...their dual-core CPUs are a generation behind AMD's, their CPUs generate far too much heat, their naming scheme is so inane that the typical consumer will never be able to make sense out of it, etc.. Suffice to say, though, that this "well-managed" company now believes that its salvation lies in producing CPUs and such for various other devices that will inevitably use commodity technology.
On an interesting side note, as far back as 1990 I always thought that Intel should have created their own operating system. Given their deep pockets, they could have suffered losses for years while they developed it. Microsoft always used their operating system profits to subsidize other investments...Intel wouldn't have had any problem attracting a variety of people from Next Computer, Sun, SGI, Apple, and all sorts of other computer companies to create such a product.
In summary...Intel is not and never has been a "well-managed" company. They've made huge and repeated mistakes over the years and continue to do so today. Put your money elsewhere.

Google - $465 - SELL above $250.
I started using Google when it was less than a year old after reading about how they had formulated their new approach to filtering search results. That said, I think that this stock is wildly overpriced and all of the good news for the next several years is already priced into it. It's entirely possible that the stock price will stay inflated for a long time (remember the late 1990s bubble?), but when the earnings start to significantly slow (which they inevitably will) or an earnings estimate is missed look for the PE to contract significantly.
I believe that Google's technology is far too simplistic to maintain a long-term competitive advantage. Ten years from now, do you think that you'll still want to be searching for generic terms and see them presented as an incredibly long list, or do you think that you'll want to have your search results automatically categorized into logical groups? If I search for "computer use", Google presents 979 million results. That's completely useless. You can try adding additional words, enclosing phrases in quotations, and other such things, but the fact of the matter is that searching for things purely via words that can be found on the actual pages is not an optimal solution in many, many situations.
As an example of a possible alternative, it would be nice to be able to delve deeper into a search engine's results by specifying a term and then repeatedly selecting a sub-term from a small list that the engine would intelligently provide. At any time, you could look at the search results from any part of the tree, but with each selection that you made the results would be tailored more and more specifically to what you're actually trying to find.
As another alternative, it would be nice if instead of simple pattern matching the search engine understood the meaning of the words (and let the user override its best guess.) For example, searching for the term "financial default" could return pages talking about bankruptcy even if the pages didn't contain those specific words. It could also avoid returning pages that didn't have any sort of a financial angle - those dealing with default court judgments, for example. A system like this would need to be able to do far more than simply provide synonyms for selected words - understanding the meaning of the actual words would be vital to avoid dramatically increasing the list of false positives.
The simple non-interactive data sifting that Google now performs certainly won't be the preferred method of search for many people in the future - it's simply too inaccurate. That means that a paradigm shift is coming, and companies that dominate a field often lose their elevated position when the underlying situation changes so dramatically. If Google doesn't maintain its dominance for many more years, its current price cannot be justified. Now that the value of search is known, though, Google will have to contend with defending its turf against both well-financed competitors (Yahoo, MSN, etc.) as well as endless start-ups trying all sorts of radical ideas.
In short...Google is wildly overpriced even when you take into account its impressive growth prospects. Anyone investing in this stock in the $450 range is gambling...not investing.

Bank of America - $45.55 - BUY at $44 and below.
I think that this stock will drift a bit lower in the next month or two and that will make for a good buying opportunity. The stock hasn't done much in the last five years on a consistent basis but the earnings and dividends during that time have steadily increased. It's currently paying about 4.5% annually versus most banks only paying about 2-3%. It's also significant that dividend income is currently taxed at 15% whereas interest income generated from leaving your money in a bank is treated as wages and may therefore be taxed considerably more highly depending on your situation.
Rising interest rates and the recently inverted yield curve (whereupon short-term rates are actually higher than long-term rates) usually signal difficulty for banks because it makes it more difficult for them to earn money. Inverted yield curves have not always predicted a recession, but I recently read that in the last 100 years they've always accurately predicted an economic slowdown. I wouldn't plan on making a lot of capital appreciation on this stock in the short-term, but if your investment horizon is pretty distant I think that you'll do pretty well.

Citigroup - $49 - BUY at $45 and below.
I like this stock for the same reasons that I like Bank of America, but whereas Bank of America is the second largest bank, Citigroup is the largest. The leaders in their categories typically command a premium, but in this case I don't think that it's warranted. If I had to pick one or the other I'd go with Bank of America. The growth rates of these two large companies will likely be fairly similar, but Citigroup's lower yield of 3% doesn't give it as much downside protection.

Washington Mutual - $45 - BUY at $42 and below
This is another bank stock, but it's significantly smaller than Bank of America and Citigroup. The smaller size enables it to grow faster, but it's also likely to make its stock price a bit more volatile. I see that as an opportunity. If you can pick it up in the range mentioned above you'll be getting a dividend yield in the roughly 4.8% range and probably capture some capital appreciation if you hang on beyond 2006.

- TZ

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1/22/2006 7:15:45 PM by Keenan Weaver

I-m only 17, this stuff is weird to me.

-Keenan Weaver

1/31/2006 9:53:18 PM by TZ

Google blew their earnings estimate today and the stock plummeted about $80 in after-hours trading, knocking about $25 billion off of their market capitalization (before partially recovering.) It-s amazing how many people don-t understand that they are a very successful advertiser...and nothing more. They are trying all sorts of other things (Froogle, Gmail, etc.) but none of those have proven to be anywhere near as successful as their advertising foundation in terms of income generation.
I find their "Don-t be evil" corporate mantra ridiculous. As I-ve been telling people for several days now, they apparently consider that slogan optional where money is concerned. They will fight the US government in court to avoid turning over anonymous search information due to a purported concern over privacy rights, but they-ll gladly accede to the Chinese government-s demand to filter things like "democracy" and "human rights" from their search results so that they can gain access to that market. I read that someone said that no one company could "stand against China" and so Google was therefore just being practical in doing this. I look at it differently. Every movement needs someone who will lead - someone who will draw a line in the sand and say no more. Leaders rally public opinion and serve as a beacon to others with similar thoughts that if they band together they can change the situation. Despite their self-righteous pretensions, Google does not have the internal fortitude to command such a role. They are a social activist in their words but not in their actions. Google will do whatever is necessary to get into the burgeoning Chinese market. In that regard, they are no worse than many others...but neither are they any better.
I also find Google-s ability to rationalize that they are a new breed of company - one with a conscience - disingenuous given their two-tiered share structure. The founders want to be able to cash out huge amounts of their shares to reap billions, but they don-t want the investing public - the people with their money on the line - to have an equivalent representative right to vote on Google-s future. How in the world do you justify such behavior with the corporate motto? If they want to maintain a lock on control, they shouldn-t sell so many shares. If they do sell their shares, they should be willing to give those people willing to put their money on the line a vote commensurate with their investment in the company. It-s absolutely mind-boggling that Google can contort itself sufficiently that they even try to justify such clear self-interest with some sort of higher nobility.
I read an article recently - in either BusinessWeek, Fortune, or Forbes - talking about the supposedly superior method of Google-s corporate structure. It struck me as ludicrous. They pride themselves on the fact that they have each employee spend 20% of their week working on their own personal projects so that the company can try to find the "next big thing." They celebrate the fact that they-ll happily invest in ten projects hoping to find one that succeeds. They rejoice that they-re able to simply have impromptu meetings of arbitrary individuals to discuss and resolve various issues without needing to formalize the discussions.
Yeah...right. That kind of aimless approach works when you have the good fortune to either be a monopoly (see: AT&T pre-1984 or Microsoft) or dominate an exploding market (as Google does with online advertising.) It does not work when your primary growth driver slows and you need to make sure that your investments are earning a reasonable return. That kind of slapshot "innovation", if you want to call it that, rarely works out well for the shareholder. In fact, it tends to become more and more inefficient as a company grows and you begin to lower your standards in the hiring of new people simply because you need an ever-increasing number to maintain the same growth rate. (You might be personally interviewing everyone at your company when you have a thousand people, but try doing it when you need 50,000.) What do you think is going to happen when the stock price stalls or craters and you-re no longer able to easily recruit bright, motivated people any easier than your competitors?
I-ve seen companies with Google-s mindset and potential come and go on the world stage. I think the company will earn a lot of money over its lifetime, but not nearly enough to justify the stock-s ridiculous valuation.

-TZ

2/7/2006 3:01:23 PM by TZ

Here-s an update as of 3:01 PM Central Standard Time, February 7, 2006:

Microsoft - $27.20 - BUY at $24 and below.
Current price: $26.93
Summary: This dipped a bit before popping back up to $28 (because of a moderately good earnings report) and has since drifted back down. I still think there-s the opportunity to ride this for an easy 10-20% if it nears my target range (based upon the release of Windows Vista), but I wouldn-t buy it at this price. There are better deals to be had - especially in the financial sector.

Intel - $25.75 - SELL above $20.
Current price: $20.61
Summary: Assuming that you had shorted this stock when I went negative on it, I-d take my profits at this point. It-s down about 20% from where I said to sell in less than three weeks - the easy money has already been made. Intel-s future prospects are still bleak, but many people still believe that it will someday regain its former glory. It won-t, but given its prodigious cash flow it probably won-t drop much farther from its current price for the foreseeable future.

Google - $465 - SELL above $250.
Current price: $367.92
Summary: Google has dropped over 20% since I said to sell. Admittedly, the timing was a bit lucky...momentum investors could well have pushed the price up over $500 if the recent earnings report hadn-t significantly disappointed the street. Whether it-s $465 or $367, though, doesn-t really matter. There-s only one way that you-re going to make money on this stock, and that-s if the short-term momentum continues long enough for the price to be pushed north of where you bought it and some guy who doesn-t remember anything about the last bubble takes your shares off of your hands for even more than you paid. Anything is possible, but I certainly wouldn-t bet any money that I would miss on such a proposition.

Bank of America - $45.55 - BUY at $44 and below.
Current price: $43.57
Summary: Bank of America is currently just under my target price so I-d be accumulating it at this point. I think that it will do well over the long term, but 2006 could be a bit bumpy given the inverted yield curve, the Fed possibly over-tightening, the economy probably slowing down a bit, etc.. (These are issues that will affect all banks, and it-s part of the reason why you can pick them up so cheaply right now.) The dividend will probably be raised to $2.20 per year in June, 2006. At $43.37, that means you-ll be making over 5% a year...and only getting taxed a maximum of 15% on those earnings. That-s about twice what you-d make in a good money market account nowadays, and probably about half the tax rate you-d owe on the interest that you-d accumulate in such an account.

Citigroup - $49 - BUY at $45 and below.
Current price: $45.12
Summary: Citigroup did briefly drop below my target price but quickly popped right back. I think that it will do acceptably over the long term, but I like Bank of America and Washington Mutual a bit more.

Washington Mutual - $45 - BUY at $42 and below
Current price: $41.99
Summary: Washington Mutual has dipped below my target price a couple of times since I recommended it. I think that over the long term an investor will probably do well with this stock from both a capital appreciation and dividend standpoint. I continue to believe that it-s a solid investment if you have a long-term perspective.

-TZ

2/9/2006 4:15:08 PM by TZ

Google continues to fall. As of the market close on February 9, 2006 it was sitting at $358.77, down $10.31 (2.79%) for the day. That-s about 23% below where it was when I initially said that it was extremely overpriced. This is exactly why I was so negative on it when its price was nearing $500. High-profile stocks such as Google that are growing extremely fast inevitably see their price tags come falling back to Earth at some point. The reason could be a missed earnings report, a general market downturn, or possibly just a lack of new buyers willing to pay such an exorbitant price. When the momentum changes, though, there-s often no base of support anywhere near the stock-s high and it often falls precipitously.
I still think that as an organization they haven-t proven themselves capable of repeating their financial success in any other market. That strikes me as a significant problem not just in finding new ways to grow (which will be necessary to maintain such a high PE ratio), but also because it means that they-re extremely non-diversified in terms of their revenue stream. If a competitor begins to take market share or advertisers begin to cut back on their online ad growth, Google could suffer significantly.
Google-s days of skyrocketing stock growth are now over. I certainly wouldn-t rule out "bargain hunters" jumping into the stock from time to time after a drop such as this (and providing a fairly good bounce), but the stock is still priced such that a lot of things need to go right in the future to justify the current price. Given the limited upside, I don-t see a reasonable risk-reward scenario for this stock.
I think that all of the easy money has already been made on Google. At this point, you-d be lucky to make a 10% annualized gain over the next 3-5 years, and you-d be putting yourself at considerable risk to realize even that given their lack of diversification, the competition, and their inability thus far to demonstrate that they can repeat their financial success in any market other than serving text-based online ads. There are better investments.

Microsoft stock has declined for the past several days. If you held Microsoft stock for the last five years, you-d have only made about 2% including dividends. That means that you-d have lost quite a bit of purchasing power after factoring in inflation. As of today the stock is at $26.66, down $0.25 (0.93%.) I think that on a fundamental level, Microsoft-s stock has two problems. First, the stock is still priced as if they are growing at 20% a year when in reality they-re lucky to hit the low-teens. Increases in earnings are primarily just contracting the PE ratio rather than pushing the stock higher. Second, they have been running into the infamous "law of large numbers" for years. Basically, when your market capitalization is $275 billion and you-re generating earnings north of $12 billion a year, it-s extremely difficult to find new markets that are large enough and profitable enough to make a significant difference.
Personally, I think that Microsoft should embrace their new reality a bit more vigorously. They are no longer a growth stock that can regularly grow their earnings at 20% a year - given their size, those days are past. They-re really more of an industrial now...a monolithic entity producing loads of cash whose fortunes will tend to correllate fairly closely with the markets over which they rule. If I were them, I-d start by doubling the dividend. That would still give them plenty of cash with which to buy back stock, do deals, and finance new development efforts. Increasing the dividend would establish a higher baseline for the stock, start attracting value investors drawn to the better yield, and guarantee investors that even if the stock stood still they-d still be just about matching the average rate of inflation.

-TZ

2/13/2006 9:49:13 AM by TZ

The Google pain continues...as of 12:03 PM on February 13, 2006 it-s sitting at $342.54, down $20.06 (5.53%) for the day.

It will be interesting to see how far it can fall before investors start diving in to try and catch a potential bounce.

-TZ

2/28/2006 11:00:39 AM by TZ

It-s absolutely hilarious.

As I wrote and suspected, it didn-t take long for "bargain hunters" to pile into Google-s stock after its recent fall. Why was it perceived to be a bargain? Well, primarily because its price had dropped back to levels not seen in almost three whole months. Surely, anything with so much buzz and that had been priced so highly must be a screaming bargain after its price had dropped 25% or so.

Surprise, surprise...such flawed logic isn-t necessarily true. Google-s CFO came out today and said that growth was slowing. No kidding. Of course it-s slowing...you can-t grow at 80-100+% forever. That-s exactly what I was pointing out previously and as the sales inevitably slow the PE multiple will begin to contract. That will make it even more difficult to make money on the stock in the years ahead.

In intraday trading today the stock was down more than 10% from its close yesterday of $390.38. It touched $339 - a drop of $41. Why people feel the need to jump into such stocks is beyond me. Would I buy the company at a reasonable valuation? Yes. Would I even remotely consider buying it when all of the good news for the next 5-10 years is already priced into it? No way. Sometimes the best investment decision you can make is not to make a particular investment.

-TZ

3/3/2006 10:22:46 AM by TZ

Intel just slashed their first quarter 2006 sales forecast by half a billion dollars due to increased competition from AMD (their fault) and slowing computer sales (the result of being far too dependent on an industry that-s well past its growth peak.)

Intel-s stock dropped 2.3% to $20.01 in intraday trading. As I previously wrote, there are so many true-believers still hanging around waiting for this stock to finally get its act together that even in the face of such bad news the damage to the stock is limited.

A stock is not a bargain simply because it was once more expensive. A company is not a wise investment simply because in different times it grew at exceptional rates.

Take these words to heart if you plan on investing in Intel for the long-term.

-TZ

4/27/2006 4:23:50 PM by TZ

I had mentioned that it would be interesting to see how much of a pop Google got in the near future...given human nature, you just know that something that went so far up is going to have a ton of people jumping back into it at the first sign of good news. Sure enough, as of today it-s back up to $420 - that-s about a 23% increase in a couple of months. Once again, it-s wildly overpriced based on the fundamentals. This reminds me of Sun Microsystems (SUNW.) That stock was incredibly overpriced back in the days of the bubble, so when it dropped waaay down to $20 you had people piling in because, well, it used to be "worth" over $60. As infallible as that logic may be, reason eventually prevailed. Today Sun is worth about $5 per share. I don-t think that Google will fall nearly as far or as fast, but I think that as the growth inevitably slows - as it is already doing - the astronomical PE will contract rather than the stock price continuing its meteoric rise. That means that if you-re buying the stock at these prices, your headroom is going to be severely limited.

As predicted, Intel settled in at about $20. It-s been down to almost $19, but just broke $20 today. I suspect it will sit within 10-15% of that price for the next year or so, barring some spectacularly good or (more likely) bad news.

The financial stocks that I mentioned have all done spectacularly well. My favorite of the group was Bank of America and it-s up about 12.625% in about three months. Washington Mutual is up about 9% in that time and even Citigroup - my least favorite of the three - is up almost 8%. (These figures all include dividends accrued throughout that time period.) Financial stocks in general all took a nice jump today because Ben Bernanke - the new Chairman of the Federal Reserve (who replaced Alan Greenspan) - announced today that the Fed might do the logical thing and pause the regular raising of short-term interest rates to see how the economy (and inflation in particular) went over the next several months. This makes perfect sense - increases in the Federal Funds Rate take a while to work themselves into the economy and the Fed has often "over-tightened" monetary supply in the past and converted what might have been a "soft economic landing" (a period of high growth to a period of more moderate and sustainable growth) into a recession. It is better to raise rates one more time at the next meeting and then monitor the situation for a while before continuing down that path. In the end, Bernanke-s statement immediately increased the spread between the short and long-term borrowing rates. That-s good news for banks since many of them make a lot of their money by borrowing money at long-term rates and then loaning it out at the higher short-term rates. When the rates are very close together (or even inverted, as they recently were) it makes it much more difficult for banks to make money (although the larger, more diversified ones such as Bank of America still make a lot of money.)

Microsoft announced earnings after the bell - the close of the stock market - today and the results weren-t good. They missed their earnings expectations by a considerable margin and announced that things weren-t looking so good for the next quarter either. The stock dropped $1.58 (5.8%) from the regular closing price of $27.25. It-s getting close to the point where it might make sense to consider a momentum play on them (based upon the upcoming release of Vista and other products that they-ve got coming online.) Personally, though, I don-t play that game...I-m much more of a value investor.

What-s particularly interesting about Microsoft, though, is where I think they-re going wrong. This is part of the reason why I originally said that I didn-t think that they were a long-term buy-and-hold stock. Chris Liddell, Microsoft-s Chief Financial Officer, said that third-quarter earnings and the fourth quarter outlook were below Wall Street-s estimates in part because the company had decided to increase research and development spending in areas where it isn-t a market leader but sees some potential. That explanation makes perfect sense, but I think that for the long-term it-s going to be a net negative for shareholders. Why, you might ask?

Microsoft-s annual revenue will soon hit $50 billion. Their history as a high-growth company with a skyrocketing stock makes them desperately want to return to their highflying days. However, just as a mutual fund like Fidelity-s Magellan runs into problems when its asset base becomes too large, so too does Microsoft have trouble earning a good return on the huge sums that they-ve got to invest in order to show substantial growth. (If you have $1 to invest, you can analyze a variety of potential investment scenarios and pick the best one. If you have $100 billion to invest, you by definition need to lower your standards as to what qualifies as a "good investment.")

The problem is that in order to generate 10-20% growth rates for a company as large as Microsoft, you have to make a lot of very large bets on a lot of very questionable sectors. This is exactly what Microsoft has been doing for about a decade. Web TV? Tablet PCs? Pocket PCs? The Xbox? MSN? These are all huge money-losing ventures for Microsoft. Think about how much you - as a shareholder - might have earned if all of that money had been invested more wisely...say, by paying it out via dividends. Microsoft-s stock would be more attractive because all of a sudden their return-on-equity would be much higher. They would be making more money (because they wouldn-t be blowing it on every software platform under the sun) on a smaller investment (since those investments wouldn-t be needed.)

In the end, I think that Microsoft would be much better served if they acted like what they truly were at this point in time - a huge, consistent, money-making machine specializing in a few key areas (such as Windows and Office software.) If they want to try and grow at a rapid pace (which requires the utilization of ever-increasing amounts of capital), they should attempt to do so with far less risk than what they-ve been doing. Fund the best ideas that they can think of in their formulative stages and then spin them off as separate companies. Microsoft could maintain a large share of the split companies (for strategic and financial reasons), use their connections and capabilities to help promote the companies and line them up with financiers, and then let the stock markets fund the majority of the "research and development", "audience building", and other expensive phases. Look at it this way...Google is worth far more as a separate company than it would be if it were simply part of Microsoft. That should tell you something - Microsoft-s colossal earnings aren-t needed to fund the best ideas out there, and allowing the market to invest in specific ideas (such as online advertising) often makes individual companies much more valuable than they would be if part of a larger conglomerate. At some point, the "strategic" value of a company maintaining complete ownership over everything that it creates is outweighed by the risk that it endures creating those ventures and the money left on the table by not allowing the public to invest (and occasionally bid to stratospheric extremes) in the best ideas.

In other financial news, I-ve been looking at MLPs lately. MLP stands for "Master Limited Partnership" and it-s a special form of (often largely tax-deferred) entity. You tend to see a lot of these types of companies in the natural gas and oil transportation services sector. As an example, check out Enterprise Products Partners (EPD) and Kinder Morgan Energy Partners (KMP.) These entities are far different than normal corporations, but have some nice aspects. In general, they tend to pay a lot of distributions (EPD is currently yielding 7.1% and KMP is yielding 6.8%) and they frequently raise the amount of the distributions. I think that owning a few of the best-of-breed of these entities makes sense. It gives you exposure to the energy sector but without the incredible volatility that you would tend to see with energy producers themselves. (Energy producers will continue their climb if prices do, but they-ll fall dramatically if oil drops back to $50 a barrel or so.) I like these investments - although I-m still learning about them - as a counterpart to government bonds. They-re a bit more risky since bad times could cause the yield to need to be cut and inflation could make their slowly increasing yields less attractive (and therefore cause a hit to the "unit"/share price), but they pay a nice premium over long-term government bonds and should help to reduce volatitility in a nicely diversified portfolio.

-TZ

4/30/2006 4:08:59 AM by TZ

Microsoft stock plummeted Friday in response to missing their quarterly numbers. They ended down $3.10 - a whopping 11.38% - at $24.15. I continue to think that in this general price area you can probably make a bit of money on it, but I still don-t consider it a long-term buy-and-hold stock. In fact, I think that there are many other stocks available that offer superior long-term potential performance and with far less risk. Personally, I wouldn-t buy Microsoft stock even at this price point...as I-ve shown with the financial stocks, you can reap the same kind of gains that you-d be hoping to make with Microsoft with far more secure and less volatile investments. (The banks that I selected pay out large dividends and that serves as a cushion for the stock, preventing it from falling very much unless people begin to believe that the dividends themselves are in danger. Sizable dividends also help to ensure that management doesn-t squander too much of shareholders- cash on a multitude of bad investments. That-s why all of the banks that I mentioned had large dividends, lots of free cash flow to raise those dividends in the future, a history of significantly raising their dividends on a regular occasion, a successful history, and enough size such that they were fairly well diversified. Management quality was also a concern, and that-s where I think that Citigroup - despite its following the other financial stocks forward - may stumble in the next few years. I don-t think that it-ll be catastrophic, but as with Microsoft, I think that you can find better returns with less risk with other investments.)

It-s humorous that the market seemed to be quite surprised at the extent of Microsoft-s spending on new research-and-development. This was very predictable based both upon what they-ve been saying for many years and what they-ve been doing with the Microsoft cash hoard. This isn-t rocket science. It-s more like when George Lucas released the fourth Star Wars movie - the first in the second trilogy. The first movie was good, the second one a step down, and the third one was terrible. You should be able to spot the pattern. Guess what the quality level of the fourth movie in the series was destined to be? That-s the reason why I laughed and mocked anyone foolish enough to stand in line for days - as quite a few people back at Digital Anvil did - to get into one of the earliest showings of the fourth movie. It was so much effort for what was obviously going to be a very bad movie.

I mentioned in a previous post that Microsoft should not seek to maintain complete ownership of every potentially hot opportunity that they envision, but should instead spin off such ventures and let the public markets cover a lot of the risk (and potentially award a much higher valuation than the same business would get if it were a fully owned part of Microsoft.) Another large problem that I did not mention is that Microsoft-s current approach makes future acquisitions made with their stock much more costly. Google, for example, is awarded an earnings multiple several times higher than Microsoft. If Microsoft purchases another company with an earnings multiple of 20, the transaction is dilutive to their stock - adding the new company-s results with Microsoft-s will result in lowering Microsoft-s earnings per share (because Microsoft is not awarded such a high valuation.) Google, on the other hand, could purchase the exact same company and actually have their earnings be accretive - it would improve their earnings per share because Google-s valuation is higher than the target company-s. This is a signficant factor and it grants a considerable advantage to Microsoft-s competition. Conceptually, it-s similar to going to a bank and asking for a loan. The bank - in this case, the public markets - trusts Google more, and will therefore loan it money to fund its business needs at a cheaper interest rate than Microsoft. The analogy isn-t perfect, but it does illustrate the basic problem.

It was interesting to read various analysts- comments regarding the financial shortfall for the quarter. Many of them cited the same basic reasoning that I had mentioned - that Microsoft is spending too much money chasing every potentially hot software market under the sun. Such a strategy might make sense if your goal is to build a larger empire, but many successful companies choose instead to compete only where they-re number one or two in a marketplace, or where there is a strong strategic reason (such as developing technology with which you can differentiate yourself from your competitors.) If your goal is to maximize the return on your capital then at some point you have to weigh the potential returns that you could get with the huge risk that you incur by not only funding the entire operation yourself, but also by often starting with little or no experience in that area. Worse, many of the markets that Microsoft is targeting are only potentially valuable. I-m sure that WebTV - an example that I previously cited - sounded like a good idea at the time because of the optimistic adoption rates that Microsoft executives envisioned. In the end, though, despite Microsoft purchasing the company for $400 million and investing hundreds of millions more, the idea never got off the ground and was a perennial money loser for them. The basic idea was valid, but Microsoft-s execution was poor (because they had no experience in that area) and the technology needed to make it all a reality wasn-t yet ready. (It-s kind of similar to the Apple Newton. It was basically a Palm Pilot, but so far ahead of its time that the money invested in developing it was pointless. The people that eventually profited from the basic idea came along much later.)

Banking stocks continued their ascent on Friday. Bank of America added another $0.88 (1.79%) and Washington Mutual another $0.29 (0.65%.) Citigroup had a great day and added $1.80 (3.74%.) Bank of America is now up about 15% since I recommended it. Citigroup is up about 11.1%. Washington Mutual is up about 10%. Intel - the stock that I highly recommended selling - is down about 22.7%. Google is down about 10.1% - it had been down much more, but - not surprisingly - bounced back quite a bit. (I continue tol think that it-s long-term returns from its current inflated valuation won-t be good.)

I-ve listed these results for amusement, but I don-t really subscribe to thinking about the nice jump in the financial stocks too much because I wouldn-t sell them at this point. I recommended companies in the financial sector for investment because many of them were clearly undervalued. That said, being undervalued doesn-t really mean anything...an "undervalued" stock can remain undervalued for a very long time (just like it sometimes takes years for the air to come out of overinflated stocks.) If you are going to invest, pick good, solid companies, buy them at a reasonable valuation, and then hold onto them until their competitive position is in jeopardy (which hopefully might not be for a long, long time.) In the case of these stocks, I figured that the bad news (such as the inverting yield curve, the slowing housing market, etc.) was already priced into them and they were poised to jump at the first sign of any good news. The Federal Reserve had to stop raising interest rates at some point, and I had always figured that would be at least one of the catalysts needed to jumpstart the banking stocks. It-s nice that the market quickly realized that a lot of solid financial stocks were undervalued, but since I-d hold them for many more years, a short-term jump like this doesn-t really do anything other than make you feel like you got in at a good price. I think you-ll be able to make a nice, relatively stable (over multi-year periods) 9-12% per year with these banking stocks (although I-d still lean towards Bank of America and Washington Mutual over Citigroup.) That-s a good, solid return. At some point, most people learn that the stock market isn-t just about making money...it-s also about making sure you don-t lose it.

-TZ

5/8/2006 5:25:30 PM by TZ

Washington Mutual had a nice pop today - it jumped $0.83 (1.82%) to $46.33. This was due to Wachovia - a larger bank - striking a deal to buy Golden West Financial. Golden West is a mortgage lender specializing in "option ARMs". Option ARMs are adjustable rate mortages where the interest rate varies (based upon the current interest environment) and where the borrower can elect to modify the size of their payment (with any shortfall simply being added back into the principal owed.)

The speculation is that Washington Mutual - another large mortgage lender - will be purchased by someone such as Citigroup. Those rumors have been swirling for a while now and the Golden West deal simply stoked the fire.

Washington Mutual is now up about 12.6% from where I recommended it be bought (including dividends.) Nice...very nice.

Bank of America is currently sitting at $50.11...that-s about 16.1% above where I said it made sense to pick it up (again, including dividends.)

Interestingly, while it feels nice to have your suspicions about such companies quickly reaffirmed by the general marketplace (which bid up the stocks from the low point that I selected), it isn-t all as positive as you might think. The higher price now makes it more difficult to purchase them as a value play - they-re still cheap, but not nearly as cheap as they were a few months ago. I think that this is the primary difference between what I-d call a "trader" and an "investor." The trader looks to outmaneuver the market by quickly jumping into and out of select stocks. The trader is very concerned with the short-term movement of the stock - it takes center stage over things like the long-term value of the company and its fundamentals. (The long-term outlook may be considered, but only insofar as it-s likely to generate a significant short-term jump in the stock.) The investor, on the other hand, would just as soon see a purchased stock drop down a bit so that more could be accumulated. If the market doesn-t see the value now, it will eventually. Since an investor doesn-t plan to sell on any short-term jumps in the price, then any such short-term jumps really don-t mean anything...except that it will be more expensive to acquire more shares.

-TZ

6/1/2006 2:45:14 AM by TZ

Wow...Microsoft stock has been taking shot after shot in the chops lately. Today (actually, May 31, 2006) was a generally up day for the stock market, but Microsoft dropped another $0.50 (2.16%) to $22.65.

Humorously, Ballmer gave a speech today to rally shareholder support...you can decide for yourself how well that went.

I found Ballmer-s recent comments regarding Microsoft-s cash hoard extremely disconcerting. They said that they were planning to keep a huge mountain of cash on hand to pursue various investment opportunities. As I-ve previously discussed, that is most assuredly not a good sign.

I think that the stock is a fair value at this price, but given their current direction it-s quite likely that only momentum investors will make any money off of the stock for the near future. (You-ll probably see it go up a dollar or two, and then drop a dollar, etc..) The opportunity cost of investing at this point is too high in my opinion...as I-ve said previously, there are better deals to be had.

-TZ

6/12/2006 5:22:37 PM by TZ

Microsoft and Intel continue to fall....

Microsoft closed at $21.71 today, down $0.21 ($0.96.) Intel closed at $16.86, down $0.30 (1.75%.)

I-m still not buying, but Microsoft is starting to look fairly attractive in terms of its valuation. The total market capitalization of the company is about $221.47 billion and they-ve got about $35 billion in cash. The whole company is therefore being valued at about $186.47 billion and they should be making at least $12-14 billion a year for the next several years. That-s roughly a 7% annual return and I suspect that they-ve still got a bit of growth left in them.

Google closed at $381.54, down $5.03 (1.30%.) I still wouldn-t go near it at this price.

June 13, 2006 Update: Microsoft fell another $0.20 to $21.51, down another 0.92%. Ouch.

1:16 AM, June 16, 2006 Update: Bill Gates announced that he was going to be stepping down from day-to-day responsibilities at Microsoft late yesterday within the next couple of years. It-s the end of an era. It will be interesting to see how this affects the stock...it bounced up a bit today, to $22.07 a share. (The announcement did not come until after the stock market had closed - Friday the 16th will be the first day that the news impacts the stock.)

-TZ

8/2/2006 5:03:56 PM by Judith M. Dodd

This page is awsome. Thanks for the tips and advice. I like your reasoning and your clear sited honesty. Thanks Judy

-Judith M. Dodd

8/2/2006 7:26:33 PM by TZ

Here-s the latest as of today...

Bank of America - $51.96, up 19.2% plus another 2.25% or so in dividends in about six months. This is a stellar result given the relatively low level of risk that was involved. That said...I don-t invest for short term gains, and I have no plan of selling here even though I know that BofA won-t be able to repeat this performance anytime soon...in fact, I wouldn-t be surprised to see it bounce around within 8-10% of this price for the next year or so. I caught it at a low point and it has now reached a much more reasonable valuation. I wouldn-t buy it here, but I-d watch for some extended news that might enable you to pick it up in the $46-47 range. Because Bank of America is a good example of what I look for when investing, I thought I-d list the specific reasons that I originally found it attractive:

* Long history (in this case decades) of solid dividend growth. BofA just raised their dividend again...a whopping 12%. Within 5-6 years I should be earning about 9% - and growing - on my original investment via the dividends alone. The capital appreciation on the stock, of course, will add considerably to that.

* 4.0% or greater dividend yield. Large dividends help in several significant ways. First, they provide a significant cushion for the stock. If some bad news hit Bank of America tomorrow, the downside would be limited because as the stock price drops the effective dividend yield - which is a constant value - increases. Second, it makes it far easier for a large, stable company to deliver a 10% annualized return (which is my ultimate target.) Third, through at least 2010 dividends are taxed at a maximum rate of only 15%, and sometimes far less. That-s a significant tax advantage over what many people get taken out of their paycheck. Fourth, considerable dividend payouts keep management from foolishly wasting investors- money trying to conquer every new market under the sun and build a sprawling, inefficient, bloated empire. (See Microsoft.) Lastly, if you reinvest the dividends earned (which are typically paid out quarterly), you-ll be taking advantage of the volatility inherent in every stock and picking up more shares in those situations when the stock is temporarily depressed.

* Cash flow roughly twice the size of the annual dividend payout or greater. Companies that can easily afford to keep paying their stated dividend pose far less risk of having to trim it. In a worst-case scenario, buying Bank of America when I suggested it would have been giving you a considerably better return than what you could have earned in a 5-year CD...and remember...that-s the worst case. I tend to stick to companies that aren-t paying out more than about 50% or so of their annual cash flow.

* Good-sized (or in this case very large) company able to withstand economic ups and downs via their diversity. Mortgage growth is slowing dramatically, for example, but that-s just one part of BofA-s overall business and not likely to significantly impact them directly.

* Not harmful to animals.

-TZ

1/29/2007 1:28:42 AM by TZ

As I wrote a year ago, Microsoft-s share price managed to break $30 due to anticipation of Vista. It-s currently $30.60.

I will stick by what I said then. If you purchased it when I said that it was starting to look fairly attractive ($22 - $24), I-d be unloading it at this point. I think that it will trade between $27 and $35 for a while, but I think that the odds of it hitting $25 again are more likely than it hitting $40. Given the pitiful dividend, I don-t think that the risks of holding on to it at this price are justified.

Bank of America was recently at about $55 but has since dropped to $52. If it hits $50 I-d consider it a nice conservative buy. They will likely increase their dividend from $2.24 to $2.48 in another six months. At $50, that would mean that the stock would be yielding almost 5%. Nice.

-TZ

3/19/2007 1:34:35 PM by TZ

It looks like it was a good call to sell Microsoft when it recently hit $30.60. As of the start of trading on March 19, 2007 it-s sitting at $27.33 - a drop of almost 11%.

I-ve been largely focused on MLPs (defined in an earlier message) since last year (as well as some financials)...APL, BGH, CLMT, CPNO, EPD, ETE, ETP, HLND, MWE, PAA, SXL, VEH, XTEX and many more. The sector is definitely attracting more money than it used to and as a result it-s getting increasingly difficult to find good deals. XTEX recently had a bit of a drop but I think the selling was overdone. They had some significant damage from Hurricane Katrina - a temporary issue - and are also investing a lot of money to grow the business in the future (which will impact their cash flow in the near term.) I think that the stock price will be considerably higher in two years and it-s expected to pay an annual distribution of $2.24 - $2.34 in 2007 while you wait for the good news to materialize. If you pick it up for $33, that would imply a largely tax deferred yield of about 6.8-7.1%.

I picked up some HBC recently in the $85s as a bit of global diversification. It-s currently yielding about 4.5% and should see some significant growth over the next 10-20 years given its proximity to the fast-growing Asian markets.

-TZ

5/3/2007 11:33:26 PM by TZ

It became known after the market close today that Microsoft was looking to open formal purchase talks - again - with Yahoo. Microsoft closed at $30.97. Yahoo is currently valued at $28 per share - roughly $38 billion. The purchase price for Yahoo (including the inevitable premium) is estimated to be $50 billion.

Think about that for a moment. Microsoft is thinking about spending $50 BILLION dollars in one shot. That-s a huge investment and one that, if I were a shareholder, I-d want to make sure had a reasonable chance of providing a very good return on the invested capital. So...is this a well thought out deal?

In a word, no. The situation is basically that, as I mentioned earlier, Microsoft has always leaned towards increasing the size of their empire and not necessarily providing the greatest return to their shareholders.

Given this news, I would say that it-s another good time to sell Microsoft. This will end badly. By that I mean that large sums of shareholder cash will be lost or at the very least suboptimal returns delivered.

The basic reason for the merger is that Microsoft is getting killed by Google in the advertising search space. Yahoo is getting beaten senseless as well, but at least they-re still conscious. So...what do you think will happen when you combine two losing companies? That-s right...you-ll probably get a bigger losing company. This isn-t hard to predict - the history of such mergers provides scant hope for success.

Think about it. Microsoft has essentially had unlimited personnel and capital to throw at the problem for many years and yet they can-t even stop from losing market share. What makes them think that they-re going to be able to right their ship if they integrate another company whose latest quarterly results were so bad that the stock dropped more than 10% in a day?

After any such merger, they would have a significantly larger percentage of the search market, but is that sustainable? If Microsoft-s or Yahoo-s recent results in the arena of search are any indication, it will simply give them a larger base from which to lose people to the competition.

Another problem I have with Microsoft purchasing Yahoo is that Microsoft is a much more "mature" company. By that, I mean that they have products that are in significant demand and that can-t easily be duplicated. They aren-t growing very quickly anymore, but the revenue stream generated by their asset base is very dependable. They will face more competition as other approaches, like free advertising-supported word processors, begin to take hold. Such competition, though, is still years away from being a serious concern.

That-s not true of Yahoo. What do they give the user that can-t easily be found elsewhere? The reality is...not much.

If this merger occurs I would expect confusion and uncertainty on the part of both advertisers and Microsoft and Yahoo employees. I would expect a fair number of Yahoo employees to leave - including a number of the better ones. I would expect turf battles between Microsoft and Yahoo employees. I would expect a lack of cooperation and integration between the two divisions for the foreseeable future.

This is a perfect example of why I was previously arguing that Microsoft should dramatically increase their dividend. They still do very well with their operating systems and office applications. In fact, as I mentioned, they do so well that they don-t know what to do with the money. The smartest thing would be for them to return more of it to shareholders and allow them to diversify it as they see fit. Instead, though, Microsoft is looking to do exactly what I said they would do - unwisely invest it in a foolish attempt to expand the empire.

The final problem with this deal? Yahoo-s trailing P/E ratio is 64 - significantly higher than Microsoft-s 22. This means that if Yahoo were integrated into Microsoft it would be a considerable drag on earnings that would put downward pressure on Microsoft for years to come.

-TZ

7/12/2008 5:07:29 PM by TZ

So...how did some of my recent trades work out?

I lost a good amount of money on Bankrupt America...I mean Bank of America (BAC.) After dividends, my average price was probably about $43.50 per share. I took my losses and sold around $37 several months ago. (That may not sound like much of a loss, but I had thousands of shares.) Within days the stock jumped to $42...and then cratered to its current point of $21.67. There were two things that finally pushed me over the edge and away from my natural tendency to hold on during the rough times since, theoretically, the future should be better. First, BAC CEO Ken Lewis decided to do a little empire building of his own and was seeking to purchase Countrywide, the largest mortage issuer in the country, during a period which Angelo Mozilo, the CEO of Countrywide, called the worst housing crisis since the Great Depression. (That analogy wasn-t far off - June, 2008 was the worst June in terms of stock performance since...the Great Depression.) I absolutely hated the idea of BAC...a stock that I bought for slow, steady, and risk-averse growth...was loading up on a highly speculative play because of the theoretical future returns. News flash for Ken Lewis: no one invests in BAC because they-re hoping that you-ll make a killing buying distressed assets on the cheap. Just stick with the basics, maximize efficiency, and hedge sufficiently such that you have significant downside protection. The second thing that convinced me to sell Bank of America was that I had recently read about how JP Morgan Chase - another large US bank - was very efficient at managing losses on its credit card operations. They were currently seeing defaults running at about 4% and expected them to increase to 6% over the next couple of years. Bank of America, meanwhile, was already seeing defaults of 6%. I figured that, if the consumer-s ability to repay debt worsened as many were expecting, then Bank of America-s defaults would probably rise to somewhere around 8% or so. Given that Bank of America-s earnings were already being wiped out by investment losses, mortgage problems, and the like, I didn-t want to hang around while yet another shoe fell. (Earnings fell from roughly $5 billion per quarter to about enough to buy a couple shareholders a cup of coffee...as long as its not from Starbucks.)

Washington Mutual (WM) fell from the mid-to-high $40s to...$4.95 as of July 12, 2008. Happily, I sold much earlier - my average selling price was about $37-38. Including dividends, I probably lost about 8% or so. There were three primary reasons that I eventually decided to sell the stock.
First, I read a report talking about how they had screwed up the credit scoring for a huge number of people and, as a result, had given those people much better loan terms than their credit scores and would have warranted. That is not what you want to hear from a bank.
Far worse, though, was when I began to get a sense of how they were "making" much of their money. WM had a very popular loan product whereupon people could pay whatever they wanted in a given month - up to a point - and simply have the balance added to their outstanding balance. (Many, but not all, other banks had similar products.) Whoever came up with that idea should have to endure a poke in the eye from every shareholder who lost money as a result. Simply said, such a product is unbelievably risky for a bank. It works fine when home values are going up and, in effect, people are simply "accessing" equity in their house. The people in the house won-t default on the mortgage loan because, in a rising market, they can typically sell the house for more than the original balance plus any additional shortages that were added. In a declining market, though, such a product just amplifies the financial destruction that will occur. Further, people at risk of default may as well go ahead and take advantage of such plans to pay as little as possible for as long as possible...and only then finally walk away and give the keys to the house to the bank (with the now inflated mortgage balance.) The most insidious part of this whole equation, though, was how it related to the bank-s "earnings" (and I use the term loosely here.) As mentioned earlier, when a payment was made for less than the "default" rate (which would normally include the interest due for the entire loan amount for the month and a principal payment), the balance was simply added to the mortgage total. How, though, do you account for this on the bank-s balance sheet? Easy. It-s booked as profit! Now, I know what you-re thinking...aren-t the people unable to make their monthly house payments much more likely as a group in percentage terms to eventually default? Well, yes, of course. So...what do you think happens to those previously realized "earnings" when the loan goes bad? To be brief...those earnings get "unrealized"...they become part of the (larger) mortgage loss that the bank suffers. It-s unbelievable that incredibly well-paid bank executives - people who supposedly have some sense of risk management - would engage in such practices, but they did.
The last item that convinced me to unload WM relatively early in the ongoing credit/subprime crisis was that unlike most of the other banks in which I had invested, they raised their dividend quarterly (instead of annually) but only by a single penny (which equated to roughly 6-7% dividend growth as compared to 10% that was more typical elsewhere.) Basically, given the serious issues that I saw, the slow-growing dividend wasn-t enough to justify the risk. It-s unfortunate that the various banking executives didn-t pay as much attention to their companies- risk as I do to mine.

-TZ

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