Friday, December 28, 2007

More on Moody's and MBIA

Interesting news lately on MBIA -- stock pops recently because the Davis funds bought more than 5% of the stock and then yesterday Buffett comes out and says he is going to start offering muni bond insurance.

That's the problem with the insurers -- now that everyone is questioning their ability to pay off on the bonds they already have insured, how many are lining up to get that same guarantee on new issues? Seems like some states and cities have called Buffett and asked them to insure their bonds. Berkshire Hathaway has a solid AAA with more capital than anyone else in the insurance market so they are taking advantage of the current panic to make a dime, while its available. If MBIA and Ambac return to solid footing and start pricing insurance like they recently did -- too cheap -- then Buffett will take his money and go home.

Could see others like AIG or GE Financial Services join in as well, while the big 2 are struggling.

That increased competition could take some of the better margin business away from the big 2 (mbi and ambac), which will hurt their ability to earn their way out of this problem.

So the big question is will the same thing happen to Moody's? A tough question for me to answer but I think there are subtle differences between them that make all the difference in the world.

The bond insurers are financially weak -- there are serious questions about their ability to pay claims -- this is tangible dollars and cents at stake. Moody's renders opinions that are often wrong -- have been in the past and likely will be in the future. The value of the opinions is for both regulators and institutional investors to have guidelines -- a frame of reference -- on the credit worthiness of fixed income securities. But Moody's reputation is not the same as dollars and cents. Is it possible that new raters will try to take advantage of the tarnished reputations of Moody's and S&P -- its possible but not as necessary as with the insurers.

Some unsophisticated investors who were greedy -- meaning they didn't understand risk and reward -- chose to bless the AAA rating on CDO's to be as true as the Gospels -- hasn't worked out that way. Moody's is learning and will adapt in terms of how they rate future structured product. dumb investors have lost their money -- not likely to trust the AAA rating as much but what about all the other fixed income investors? I suspect they will trust the AAA as much as they have in the past.

Oh and those Davis boys? They owned over 7% of Moody's as of the end of September so their exposure to Moody's is actually significantly greater than it is to MBI (5% of 2.5 bill vs. 7% of 10 bill).

about ready to buy my next round -- too bad I can't (out of the office so I can't access the ethics system to get employer approval).

Friday, December 21, 2007

Moody's vs. MBIA vs. Brokers vs. other financials

MBIA, brokers, banks, etc. have all fallen since the troubles during the summer started yet I pick MCO over all of them (possible exception of GS) because Moody's has no liabilities and no assets to worry about.

MBIA is on the hook for who knows how many billions from their insurance -- potentially enough to bankrupt them or require massive capital infusions. Thursday we learned there are $8 bill more CDO issues for MBIA then we thought yesterday. That's a good chunk of capital.

The brokers -- Merrill, Bear, Morgan Stanley, Citigroup or the banks -- WB, BAC, STI, WFC, etc. -- all have had writedowns and all are likely to keep writing down asset values. Their capital is at risk from all the writedowns, which may put the firm at risk unless they are able to get more capital like Morgan Stanley did today from the Chinese.

Moody's merely renders opinions on the creditworthiness of various securities -- they do not insure those securities; nor do they own any of them and unless they lose some litigation, they have no liabilities whatsoever related to the problems all these other financials are having. Yet the stock is still down 50% from its highs.

Moody's may not be a good stock from here, but I cannot imagine how it couldn't be a better risk reward then all of these other financials because its survival is no where near threatened -- they have no need to raise capital and in fact they have excess capital that can be used to buy back stock.

FDS

Stock is down several points from its recent earnings release yet so far the only change in fundamentals is estimates have stopped rising. They are meeting numbers and showing impressive metrics (subsrciber numbers) yet their guidance is around consensus to a shade below consensus. So the reaction by investors is to lower the multiple. Makes some sense although my thought is that the problems in the industry are in the fixed income area and that is a meaningless area to Factset.

77% of revenues are from buy side clients -- without a concentration in client or client type (long only vs. hedge fund, etc.). That leaves only 23% from sell side clients -- all on the equity or investment banking side so no fixed income to lose.

Stock's PE will fight an uphill battle as long as brokers are suffering losses and layoffs but I believe the business will not miss -- they will continue their growth streak.

From a stock perspective though, I find Moody's more attractive -- Moody's has fallen further, is cheaper and has even better profitability metrics vs. FDS. No reason to sell FDS but for now the incremental dollars will go to MCO. If FDS falls further, will have to reconsider and potentially buy more.

Thursday, December 20, 2007

DFR

Well the deal is back on and its structured in such a way that it doesn't need any additional approvals -- that way it can be wrapped up before the end of the year.

So the price is better -- $180 mill vs. $290 before. The number of shares is greater, which is a reflection of the price drop in DFR. Sellers note so we don't have to worry about some covenant from a bank or bond deal causing troubles.

3 Keys to why this deal is cool:

1. Internally managed REITs get higher valuations because there are less conflicts of interest and presummably the management team has more incentive to do well.

2. Income stream is now more diversified -- asset management fees are pretty steady and simple to model -- just a precentage of the assets. Incentive fees are harder but at least one analyst has already stripped them from his model for 2008. People will use conservative assumptions on incentive fees in this environment.

3. The management side gives them a path to growth -- not too many ways to grow a bond portfolio other than getting more capital. DFR had a plan to expand ROE by going into alternative assets from RMBS and that would have a one time boost to the income from the REIT (one time but spread over a couple of years of implementation) but once that is done how do you grow?

By growing assets under management, DFR now has an easy way to continue to grow after they have shifted their asset mix in the REIT portfolio. Big yield and growth story is a potent combination.

The deal is dilutive to 2008 and if you read carefully, you should have noticed that the company said that pool of 2007 earnings that had not been distributed yet would get paid out in either the December dividend or the next one. That suggests they might keep the dividend at 42 cents but the earnings will be less than that due to the dilution (hopefully, because otherwise that means they are earning less too.)

The spread they are earning in their RMBS portfolio has widened, which should help support their earnings so to me any decline in earnings power is dilution driven.

So let's say 1.50 in dividends going forward -- that's a high teens yield and they should be able to grow that over time thanks to the management side, which showed 4% asset growth since July -- quite impressive given the turmoil in the fixed income markets.

I think the stock would be closer to fair value in the low teens.

Monday, December 17, 2007

From GGG to MCO

Did it today -- sold some more of my GGG for Moody's (MCO) -- probably not a good price for the trade but at least I have some exposure which is what I wanted. My thinking is that I am not really increasing my exposure to housing/debt/financials but rather just shifting it from Graco which was about 40% exposed to housing. I expect Moody's to be faster growing than Graco over the next several years and its selling at a similar valuation despite Moody's having even better economics than Graco which is really hard to do.

I figured my loss exposure to MCO wasn't much greater than to GGG and it could be even better protection because Moody's has underperformed Graco significantly over the last couple of years -- prior to that MCO was a better stock.

Buying MCO at almost half off and I figure that the stock will not get truly cheap because Buffett owns 18% -- he will just buy more at the right price. So will the company -- figure on $500 mill in share buyback annually which should be enough to buy back between 10-15 mill shares (265 mill outstanding now). Between the company and Buffett, I figure the stock has some downside protection. If it falls further -- say to the low 30's I will buy more. If it just pulls back to the $35 area, then I will probably just buy some options in the stock. increase my exposure without risking a lot of capital. I just figure that this round of financial declines is done -- will there be further declines? quite possibly but this round is done. Think end of March 2001 as far as the tech stocks go.

Friday, December 14, 2007

FLIR vs. GGG

Did the trade today -- sold some GGG to buy some more FLIR. If you looked at it objectively, this is unlikely to be a good trade. I did it because I wanted to have more money in FLIR then I had in GGG and I didn't want to sell something else to buy more FLIR to make it bigger than GGG.

I am a huge believer in the growth potential of infrared imaging -- I expect them to keep growing at 20-30% in revenues and to see operating margins expand while producing lots of free cash flow. That's much faster than GGG -- the reason the trade may not work is that FLIR's PE is almost 2X GGG's so much of the faster growth in FLIR is embedded in the expectations of both stocks. I guess I hope its not the case -- that FLIR will grow even faster than many believe or if not faster then at a high rate for longer than most believe.

Been moving slowly with FLIR -- now finally around HALF my eventual position (I hope) which is around 4% -- similar in size to GOOG, CME, UEPS and TSRA. That's 2X most of my other positions such as TECH, FDS, MDT, ILMN, etc. I would love to own more of the others (ex. MDT) at the right prices but so far I have talked myself out of buying.

MCO

MCO was back below $38 for a time today -- it closed at $38.5. Been doing more thinking on the issues.

1994 -- the last year the company experienced a down revenue year is included in a slide on a presentation available at their website -- it shows a 9% compound annual growth rate in revenues from 1992 -- 1996. So that period includes the peak year of 93, a down year in 94, a rebound in 95 and more growth in 96. they don't provide specifics but they do provide a log based chart and it seems to me that in 95 they got close to 93 levels but didn't beat them and in 96 they went to new highs.

That translates to 2006 = 1992 with 2007 being the peak year followed by a decline in 2008 and rebound years in 2009 and 2010 so that they are at new levels of growth in 2010. If you follow these numbers and assume a similar 9% growth rate from 2006 to 2010, then revenues in 2010 are about $2.875 billion. That translates into EPS of roughly $3.25 to $3.50 in 2010. Assume a 20-22 PE on those numbers and the stock could be around $70 -- not bad vs. $38.50 today. That's only 2 years away (we are using 2008 EPS estimates for valuation purposes now so 2 years from now we will be looking at 2010 numbers) to double your money.

What is the downside?

a. business model changes because forced to abandon issuer pays model. Stock would get cut in half again because the business would shrink dramatically. low probability but 50% loss potential (guess).

b. litigation expenses and or potential losses if courts rule they don't just issue opinions but rather guarantees -- if they lose the court case see risk a. -- big loss because the business model would be broke. Higher expenses due to litigation is one thing -- it hurts but its not that big of a deal -- losing a case means potentially losing the franchise.

c. competition in structured products ratings due to loss of credibility -- this means somewhat lower margins -- say 40% instead of 50% and less revenue growth because they are sharing more with competitors. No idea on downside -- say 25%.

d. Growth in debt issuance world wide slows to the point that Moody's revenues are still flat with 07 numbers in 2010. The great deleveraging people talk about that would hurt their revenues. Its possible -- this is the highest probability risk, yet I still think its a low number. economic growth leads to growth in debt -- its that simple -- very highly correlated so either we end up with no GDP growth for awhile (next few years) or most developed economies change dramatically away from debt. This means a flat to down stock price -- probably somewhere in the mid 20's soon and maybe $40 in 2010.

So let's say the downside from thursday's close is 33% and the upside is somewhere between 50-150% over the next few years. Good chance I'm early to the story but that is why I will buy small to start. Will dip a toe and wait for more info -- most likely bad -- then buy more when the stock dips towards $30. That's my guess. Key for me is their franchise is in tact in my mind -- they will remain a toll keeper on the growth in debt. International markets will ensure that debt grows nicely.

Wednesday, December 12, 2007

Federal Reserve cuts 25

Ouch -- with friends like the Fed who needs enemies huh? Obviously the market traders who were setting prices today were hoping for 50bps and I can't blame them. My home equity line and my financial stock exposure was hoping for 50bps too. Grand scheme of things no big deal. We were primed for a breather after the recent rally and so now we have gotten it. I suspect we will be higher from here -- if not Wednesday, then soon after.

Darn TECH -- up over $70 now!!!! had the chance to buy more around $63 and didn't because of other options that I am now wary of. ugh!!

FLIR -- a sell rating has led to some profit taking -- should have bought more today especially if I think the market will rally from here but I didn't -- always hoping for more of course. Still at the equivalent of $62 that it closed near today, its still trading at high 20's multiple -- not much room for error. Mr. Am Tech puts out a sell saying all the good news is in the stock. Quite likely right but he was just talking about 2008. Maybe some upside but most likely he is right. On the other hand is the stock already discounting the strong secular growth of the next 3-7 years? not as convinced -- think the upside is still huge over time.

MCF -- bought some yesterday -- got a lousy price but those are the breaks. I listened to a couple of their conference calls tonight and the story is very interesting -- the guy said something fascinating about their value add --- they just discovered a 600bcf (billion cubic feet) natural gas find in the gulf of mexico -- probably the largest find in 15 years yet the 3D seismic on the area had been done in 1993 -- hundreds had looked at the very same data and seen nothing but they looked at it and found a huge store of gas. they won't and can't repeat that level of success but they can find several 50bcf reservoirs, which will be quite additive to the company's value given its small size.

Anyway, I plan on buying some more -- they have a $850 or so million market cap but CEO thought they were worth over 1 billion back in april when that 600bcf find was only 430bcf -- here we are with better fundamentals and the stock STILL isn't at 1 billion. I wouldn't normally take a CEO's word on valuation but this story is a little different.

that's about it for now.

Sunday, December 9, 2007

odds and ends

CME -- an analyst report recently included charts that showed compound growth rates of 25% or more for the volume traded of each of the major contracts that are traded on CME's exchange. This year the growth is even faster thanks to the higher volatility. I have expected $20 in 08 EPS for some time but now the stock is at 35x those estimates. either the stock will settle in here or the estimates are going to have to go higher. not sure what volume estimates people are assuming now but I don't think we are up to 25% volume growth yet. I will have to double check and report back.

MCF -- Contango Oil and Gas. Fascinating company. They determined that exploration is the point where most of the value is created in the natural gas industry so they outsource everything else and focus just on that. They partner with top geologists and others in the industry to carry out operations. They construct their contracts to provide the right incentives to encourage the best from people. They have taken a small amount of capital and created enormous amount of value from it in just several years -- say $60 mill to $850 mill in just 8 years. The beauty is that they are still small and the value is asset based rather than revenues and earnings so I think there are fewer limits to how big they can get. I am not an oil and gas value expert but I understand a good strategy and management team when I see one -- these people know how to add value and generate returns for shareholders. this is old -- from dec 06 but check this link out:

http://www.ft.com/cms/s/2/c3c77068-863d-11db-86d5-0000779e2340,dwp_uuid=d8e9ac2a-30dc-11da-ac1b-00000e2511c8.html

TSRA -- they just signed a license with Toshiba -- another feather in their cap. good news in terms of their ability to get the consumer business up and running.

For those of you inclined to buy large cap stocks -- I think CSCO is pretty attractive right here -- I expect once they report again the stock will be back into the 30's. No way they are struggling while the rest of tech is doing well. they are just too well positioned. If I somehow had lots of cash, I would add this one but for now I have MSFT, GOOG, plus FLIR, TSRA, UEPS and FDS. plenty of tech exposure already. I would gladly trade MSFT for CSCO but tax costs make that impossible.

Thumb Sucking can be painful!

Thumb sucking. That's what I have been doing rather than decided to buy or not a couple of stocks. Thought about FDS and TECH each near their recent lows at $60 and $63 but was debating other stocks (MCO and QGEN, LMNX, etc). Next thing you know FDS is $65 and TECH is $69 not to mention MCO has jumped over 10%. not huge moves but a lot for just a few days.

As a libertarian free market type, I find the government intervention plan to "save" the mortgage industry and consequently the financial industry morally offensive. Nothing like violating the sanctity of contract and the mortgage holder's property rights by deciding that adjustable rates won't rise. If the private parties involved choose to modify the terms that's ok because its their decision -- the government getting involved just distorts everything.

As an investor and employee in the financial industry, I like the idea of stability and an end to the snowballing effect of foreclosures. The question is whether this marks the end or just a pause in the decline -- i.e. are we around March/April of 2001 (pause) or October of 2002 (end).

If its the end, then paying up a bit for MCO or FDS or TECH isn't so bad but if this is just a pause then we need to show some patience.

One thing is for sure -- sentiment is very bad right now. Hedge fund exposure to stocks is low and a lot of stocks -- financials are oversold. That means the market is going up.

Met with a wall street strategist recently who made the case that investors are crowded into stocks in certain sectors -- those with high international exposure like energy, materials and industrials. Its all a play on the secular theme of china driving demand and setting prices for all kinds of materials and infrastructure products. China is likely to see a slowdown in 2008 or in 2009 (post olympics) due to the monetary policy that China has in place. A slowdown in China will coincide with a pickup in US growth thanks to the fed's cutting rates. He argued that financials and consumer discretionary would be the best performing areas. I can certainly see that happening but I would point out he is a secular bear on financials -- he merely sees a cyclical rebound next year in the midst of long term struggle.

He also argued that emerging markets stocks would pull back next year -- performance has been too good and too many are too complacent about it continuing. My asian fund managers -- Matthews agrees -- they are conservatively positioned in undervalued securities -- that is hurting performance on the upside but will protect capital on the downside. I think everything the strategist said is likely to happen -- not sure when but I suspect it gets started around May of next year -- just seems like that is when the market has made changes the last couple of years. Not sure what actions I am going to take in my portfolio.

If financials do well next year, I think FDS's multiple will expand again and I think the pressure on DFR could loosen but that's very little exposure for me relative to what I have in energy and asia. might need to take some profits in the asian funds. I think health care -- especially LH could do better next year if attention shifts back to the US and so that could help me too.

not a big fan of any consumer discretionary stocks --own none right now. MCO could be my financials play.

more later.

Wednesday, December 5, 2007

TECH, QGEN, LMNX

The other choice I have been thinking about is adding to TECH or buying a new position in either QGEN or LMNX or something else. TECH is a great story but its a stock that has struggled and given the valuation and the relatively slow growth rate (but very consistent) I'm not sure the sluggish stock price is going to change.

QGEN has been a stronger performer in a related field -- they sell sample prep technologies that help automate lab processes when dealing wth nucleic acids (DNA/RNA). QGEN is also branching out into molecular diagnostics or testing based on DNA type stuff. I looked at the huge debt and the large goodwill on the balance sheet of QGEN and decided no thanks -- I realize they are a good franchise but I'm just not willing to bet on them -- if their franchise is so great why do they need to go out and spend a huge amount on buying Digene as a transformational deal that might move them more into diagnostics but will also change them from many products to a big concentration is just one -- HPV testing (cervical cancer).

LMNX provides DNA and protein analysis tools that can handle multiple tests on a single sample. Their business model is to partner or license their tech to others including TECH and QGEN. They have 4700 boxes in the field and they earn revenues for the systems (wholesale price, which is marked up to customer by their partners), for the consummables used in testing and royalties on total sales by their partners. its been a decent story though its never panned out as well as expected. If that's all there was, I might be more interested but ILMN's new Bead Xpress device is a competing instrument -- I have heard demand for the Bead Xpress is pretty strong for a new product so I am wary of buying into a competitor in LMNX. Now the good news for LMNX is that they are selling 600-800 new boxes per year and so far ILMN has sold maybe 40-80 so it will take awhile for ILMN to catch up if they ever do.

Interesting part of LMNX story is these partners -- 50 deals so far with 32 partners actually selling equipment and generating revenues. But only 4 account for about 47% of revenues so the rest of the partnerships haven't gotten too far yet. It takes time to take LMNX's technology and use it to develop new tests and get them into customer hands and change scientist behavior. My understanding is these partners are going to introduce several new products next year, which should accelerate growth. Don't know for sure. LMNX is also developing their own tests and they have some due to be introduced next year so that is another source of growth for 2008 and beyond. need to do some more research before deciding on this one.

finally a new post

Well its almost been a week since the last post -- man that sucks. I keep hoping I will find the time but then too many other issues pop up.

Interesting times to say the least. My thumb sucking on BOOM has led that stock into the 60's last I checked -- nice move. Oh well. I also thumb sucked on FDS -- a stock I own and hoped to buy more of but kept waiting for a lower price then $60 -- today it was around $65. TECH is another stock I have been watching and waiting to buy more of -- a week ago it was in the $62-63 range but I still didn't buy and by the end of today it was near $67.

In the case of FDS and TECH there are 2 reasons why I held off buying more -- MCO and LMNX/QGEN.

MCO or Moody's is a great franchise -- they own a toll on the issuance of debt. The issuer pays a fee to have Moody's rate the debt and then publish their ratings for all to see for free -- interesting model. Most pick on them for conflicts of interest and everyone rails against their horrible ability to predict the future -- yet they are a valuable tool for fixed income investors just like I believe equity sell side research is a valuable tool for investors when used properly (unlike how they were used in 1999-2000). Anyway, MCO has 50% operating margins and no real capital requirements so the business has enormous returns on capital and thanks to the constant growth in debt throughout the world -- they have demonstrated consistent growth in revenues over the last 20 years (1994 the one exception). Right now the low end of estimates says next year they will earn around $2.10, which equates to an 17 or so PE using $36 price. That said, don't forget that estimates have been dropping and the idea the stock is cheap can only be based upon the idea that future earnings power is near these numbers -- take EPS down to $1.50 and the stock is expensive.

The stock is down 50% from its highs -- so right away my interest perks up because this HAS BEEN an incredible secular growth stock that is now at a half off sale. But that's just a starting point -- questions to be answered: what about lawsuits and all the other regulatory talk? what about conflicts of interest -- will business model change? Will there be any new competition or any other reason for margins to decline? What will growth be like in the future -- has there been well above normal growth that will need to normalize i.e. experience a slow period? At what point is the stock low enough to buy?

I would love to be able to talk to the sell side analysts at this point to find out what investors believe -- what are they asking about -- if they are questioning the franchise because of concerns about rating agencies conflicts and how their ratings have been wrong, then I want to buy with both hands. If they are dispassionately noting that debt issuance is likely to grow much slower for a few years and that 2008 will see sharp declines in structured products that will drag down estimates below $2, then I might nibble. If they remain too bullish because they refuse to give up on the wonderful story Moody's has been, then I want to stay away.

A reasonable case is that 2008 stinks but after that debt issuance picks up again and in 3-5 years the company is able to earn $2.7 to 3 bill in revenues, which translates into $1.3 to 1.5 bill in operating profit or about $3.40 in EPS assuming they continue to use their free cash flow to buyback stock. I could easily make the case that the stock will double from here in the next 3-5 years. I could also make the case that the stock will continue to fall into the 20's as issuance continues to drop and they face margin pressure -- this is an industry not used to competing on price but also not used to facing declining revenues either. I could make a best case and assume they reach more like $4 bill in revenues in 3-5 years. That could drive a stock price over $100 or a triple from here.

still thinking about this one but its not often someone holds a half off sale on a business with this kind of profitability. Still to circle back to my original point -- to me exposure to MCO is exposure to capital markets which FDS also provides in a certain way so I would rather not add to FDS AND buy MCO -- need to decide on MCO and if its a No then there is no reason not to add to FDS.

Tuesday, November 27, 2007

Citigroup's new friends

So citi raises $7 bill or so from middle eastern friends -- but takes another 6+ bill in charges too. Given the size of Citigroup, $7 bill is a joke -- a rounding error -- and the terms of 11% rate that Citi will pay on the funds till they are converted (if they ever are) is pretty steep -- close to 2X what Citi was paying prior to that deal. That said, Cramer is right -- don't forget the situation is better than it was.

Obviously Citi is in trouble but this move does help some -- I'm not smart enough to say this means Citi is bottoming. I have said repeatedly that financials are to be avoided and I haven't changed my tune -- we have not had the kind of failures that I would have expected given the situation.

Companies with large international businesses and secular growth drivers are the place to be. Last stock I mentioned -- Boom -- can you believe the progress it has made since then -- i.e. since last Tuesday prior to T-day? Its up like 10% since then or at least it seems like it. I never bought.

Latest reading was about ELMG which I read about in my latest Forbes. They provide wireless broadband equipment for aerospace and defense including allowing exec's to surf the web on the corporate jet. The margins are horrible, the returns on equity are bad too but the valuation and growth potential are interesting. The margins have the potential to increase from 6% or so up to 10%, which is more in line with peers. This year the defense side is up 28% after not growing for 3 years prior. The aerospace side is doing great too -- up like 40% but the warehouse logisitics side, which accounts for 50% of revenues is only up 1%. I look at these numbers and I realize that FLIR is that good of a situation. I am still reading about ELMG but so far I'm wondering why this is better that my existing ideas.

Another DNA consummable supply company that I am researching is Qiagen (QGEN) -- similar growth drivers to TECH but the growth is faster and the margins are no where near as good -- but they have been rising. Still need to do some reading to better understand the opportunity that they have. I like TECH but so far the stock has not done as well as I would have expected.

FDS -- this is one that I am wondering when to pull the trigger on -- they are going to report earnings in a couple of weeks so this is a big decision. They are trading at 24X next 4 quarters earnings which is below average but still pretty high. There is a lot of concern that their business will slow and that would hurt the stock but they have no exposure to fixed income which is the area with the most problems. They do have exposure to investment banking (deals), which was a busy area during the buyout binge. I think FDS continues to have a great future -- because they keep adding new functionality and the number of users is still very small compared to the potential pool of users.

So stocks I would like to add to include FDS, TECH, ILMN, FLIR, CLB. Stocks I am thinking about trimming include GGG, MDT, LH, etc. GGG because I am afraid they will no longer be able to keep growth up with the housing area getting crushed. Just figure that LH should be a smaller portion of the portfolio. MDT -- I'm tired of waiting for this pig to ever get moving.

that's enough for tonight -- hope you are holding up well. The secular growth portfolio is outperforming by about 9% this year -- a great year.

Wednesday, November 21, 2007

ugh!

So much to say and so little time to say it!!!! The wife headed to her family this week so I figured I would have tons of time to make lots of posts -- as it turns out -- this is it!

Fascinating stuff in the market with FRE and FNM plunging yesterday. Glad to see MDT's not as bad as thought -- still debating sellng that one -- at least some of it.

People still saying silly things about the dollar -- smart guy this week said that our future demographics issues with social security and medicare will cause the budget deficit to get big and hurt the dollar? Hello? Are you kidding me? Have you looked at the budget situations of our competitors in Europe and Japan? whatever. If the dollar continues to fall, it will be against non euro/yen currencies for reasons other than social security.

that wells fargo ceo? he said a few things noteworthy -- first, that we are having a severity problem in mortgages meaning its the high loan to value mortgages that are failing so the bank takes a big loss on each one. The other option is frequency, which is driven by employment -- meaning people lose their incomes and that causes them to miss payments and foreclose. Most of these loans are going to have good asset security -- meaning lower loan to value ratios so the banks don't lose as much on each loan. Since its a severity issue, we will reset home values and wipe out a bunch of homeowners and bank capital but then because employment is good, rates are low and there is liquidity in the markets, we will rebound quickly.

let's hope we keep the employment up then!

interesting company I have been reading about lately? BOOM. great business during upcycle in energy -- not so great otherwise. valuation high. looks like great management team. still thinking -- trouble is I have no idea what advantage I bring to predicting future explosion welding demand?

Friday, November 16, 2007

the next depression?

Wells Fargo's CEO presented at a Merrill Lynch financial services conference today and said the housing issues have a long way to go before bottoming. Cramer described his comments as suggesting a depression was coming.

Interesting comments. On the one hand, Wells is a far better manager than most financials that are suffering write offs -- meaning Wells has avoided writeoffs. On the other hand, Wells is based in CA one of the epicenter's of the current crisis. He might be extrapolating too much from the bad CA numbers he is seeing to the rest of the country.

I don't know the CEO so I don't know if he tends to hyperbole or not -- most bankers you would assume are not into hyperbole.

Certainly makes you wonder though about the economy -- if home values drop like he talks about, what impact will that have on the economy? This is what is driving the market lower right now. Again -- we are ready for a rally again -- probably a better one than the one day wonder of Tuesday -- market has a habit of bottoming in expiration week -- which is this week. I bought more CLB yesterday at 128.75.

I think Cramer is right that without energy this market sucks -- Ag, energy, infrastructure, etc -- most of the bull markets he talks about are driven in some ways by high energy prices.

more this weekend.

Tuesday, November 13, 2007

DFR -- must have been drunk when I wrote that last comment

Everything I wrote the last time about DFR was partially true -- it is a cheap stock with a high yield. They do have quality assets and in some ways they are a better buy than most bank stocks. Problem is that the one way they aren't is liquidity -- they are at 14X leverage -- a few percent drop in their AAA mortgages thanks to spreads widening and they may have trouble making margin calls on the RMBS portfolio.

that extra risk is a huge deal. Its why DFR is a dangerous stock right now -- the cheap appearance sucks you in but the high leverage could wipe you out. I don't have a good feel for what the odds of wipeout are -- more than zero but less than a lot.

Monday, November 12, 2007

markets -- financials, correction, dollar, etc.

two signs we are nearing the end of the correction --

1. financials no longer going to new lows (banks report bad charges yet don't hit new lows)
2. tech stocks -- the darlings of the recent market are beginning to experience a correction.

When investors/traders throw out their favorites it means they no longer feel safe owning any stocks. Its a sign the decline is done but its critical to realize that the market can't bottom as long as the favored stocks are holding up.

The dollar -- its dropped quite a bit recently and the first thing I want to make clear is that whenever the dollar declines, we who live and work in the US are poorer. Some pundits try to argue that the dollar falling is good for something but it is absolutely impossible for any country to become wealthier through a declining currency. by definition your currency declines in value, any assets valued in that currency decline in value too.

That said, exporters will gain share of the shrinking wealth pie because their products appear to be cheaper to foreign buyers after a drop in the dollar.

while some blame the falling dollar on interest rate differentials, I think its more to do with investors betting investment returns will not be as good in the US as they are in other parts of the world. beliefs like that occur and are reinforced as the dollar drops. but at some point -- probably soon given that some super model has decided not to be paid in dollars -- our assets become too cheap to ignore.

why would foreigners think our asset returns won't be very good? Perhaps every day they read about Congress and some of the presidential hopefuls talking about raising taxes on incomes and capital gains, etc. the Fed appears to rather have some increase in inflation then have a slowdown in economic growth. capital goes where it feels welcome -- capital rarely feels welcome where it's value is hurt by taxes and inflation.

FLIR

Added to the position on Thurs and Fri. My perspective is there has been no change to the fundamentals of FLIR -- most analyst reactions to the FLIR analyst day on Thursday were positive. The stock has pulled back because most tech stocks are pulling back and because some investors may have expected some kind of upside from the analyst meeting that didn't occur.

I think there will be upside to Q4 estimates and that 2008 results will be higher than current estimates. no hard and fast data for that opinion -- just assuming that growth will not decelerate as fast as current estimates assume.

just now getting to the point where the position is almost half the size I would like to get to before I'm done. will need to see either further declines or the passage of time (stock flat yet growth still there) before buying more.

still believe this is a great long term growth story.

Friday, November 9, 2007

DFR -- good situation

I would rather own DFR then any of the large banks or regional banks. why? they pay a much higher yield; they have high quality assets in their mortgage portfolio; they are much more undervalued.

Interesting point from the call -- we knew that a lot of their alternative assets came from deals but on the call they reinforced that these are middle market deals -- they never got frothy in terms of interest rates or payment in kind like terms -- terms were getting easier but not to the same extent that the big loans did. middle market deals have less competition and better profitability.

liquidity looks good. they reduced the size of their RMBS -- and rebalanced towards agency so that their non-agency book has dropped as a percentage of the total -- that improves liquidity a lot because its the AAA part that could see rising liquidity issues and is what everyone is concerned about in terms of defaults -- well not their AAA part but others. no one is really worried about agency RMBS.

the stock could easily make its way back up towards $10-11 based on the new book value ratios.

interesting thoughts on the dividend -- they will pay out the undistributed earnings in a dividend either in Q4 or in Q1 of 2008. for 2007 that adds up to an extra 9 cents

more later -- over weekend.......

Monday, November 5, 2007

WGRNX

I just added a 2% position (roughly) to the Wintergreen fund based on the writeup in the latest Forbes (James Grant's column) and my reading of his shareholder letters. Fund has a great track record and likes to buy great businesses at cheap prices -- his mandate is he can own anything anywhere. From stocks to bonds to derivatives from the US to other developed countres to the emerging markets, this manager can own pretty much anything. Its one of the broadest mandates I have seen.

Energy -- Its supply stupid

"On an oil-equivalent basis, production decreased by 2% from the third quarter of 2006." Exxon Q3 earnings press release.

That about says it all -- at a time when the price of oil is over $90 a barrel, Exxon, the largest oil company in the world, is unable to increase production. Many analysts are arguing that the price of oil is unsustainably high due to speculation by hedge funds, geopolitical issues, temporary supply disruptions (nigeria, iran/iraq/turkey, etc. Truth is demand is up and supply can't keep up because production growth is too difficult. Too many old fields that are no longer able to produce at historical rates. Too many new fields that are smaller and unable to produce at the rates of previous finds for very long.

Will oil drop if the US has a recession? YES! - (a hilarious suggestion given that Q3 growth was almost 4% but many are absolutely convinced we are headed for recession. no way to know for sure in 2008 but as of now -- no way we are headed for recession in the next 6 months).

I remain quite comfortable with a large weighting in energy because I am optimistic on the economic front and pessimisstic on the oil supply front.

bill miller

Pride Goeth Before the Fall

I have only read a few quarterly commentaries from Bill Miller but they have all been interesting and worth reading. For the most part I have learned something about investing from each report I have read.

I remember one he wrote for Q3 in 2005 that foretold his underperformance -- if you were paying attention. I wasn't at the time but in hindsight it is clear he was getting a little too prideful.

This report was right around the time of the Legg Mason buyout of Citigroup's money management business. He wanted to welcome new shareholders with a description of his process which included his thoughts on cyclical value (traditional value stocks) and secular value (growth stocks). He also included a story about his willingess to average down -- or keep buying more shares as a stock drops to lower his average cost. Someone asked him how does he know when a stock has fallen too far to average down -- his reply was when he can no longer get a quote.

This was partly said in jest but it was an accurate reflection of his views. Problem: it means he would never be willing to admit he was wrong or possibly worse -- that he was NEVER wrong. Either way that lack of humility is why he has underperformed and why I believe he will continue to underperform. His most recent note suggests financial stocks will be the winners going forward and that people are panicking out of their financial stocks including Countrywide Financial (CFC). He has the audacity to assume CFC is worth $40 rather than the $14 it is trading for. How he knows that CFC will even have the liquidity to survive let alone be worth $40 is beyond me. I wonder if Bill would use that valuation for CFC if he assumed mortgage originations equaled only half of their recent annual levels.

Bill has no energy, no consumer staples stocks and has 30% of the portfolio in consumer cyclical stocks (discretionary). The secular value investor has 0% in consumer discretionary stocks plus a bunch in energy -- could we be any more different in our views of the future?

time will tell who is right.

Regardless of what you think of my Bill Miller analysis, one critical point for value investors is to never ever have valuation be your thesis for buying a stock. If you say, I own stock XYZ because its cheap then when can you be wrong? if the news comes out bad and the stock keeps dropping but your thesis is I own it because its cheap then you can't sell. You have to give yourself an intellectual out for admitting defeat. Cheap stock is necessary but what you need for a thesis are catalysts for why the valuation will improve -- new products, improved pricing, new management team, etc. That way if those catalysts do not come to pass you have a legitimate reason for selling a "cheap" stock.

Friday, November 2, 2007

fed, dollar, japan, narrow market, oil etc.

Fed cut rates again -- is it me or have you noticed that most bank stocks are hitting new lows. I have told you repeatedly that fed cuts will not save the problem industries but it will make the good industries soar -- think energy, industrials, technology, materials, etc.

Everyone still freaking out about the dollar -- there are 3 factors that drive the dollar -- 1. interest rate differentials; 2. investment return expectations and 3. fund flows. right now the focus is on interest rates and maybe fund flows (those focused on trade deficit) but return expectations are also important -- our rates might be low but if our asset returns are high then money will flow to the US. we might not beat asia but we should do well vs. europe in terms of return competitions.

Japan is your only hedge. Given increased corelation of assets throughout the world -- i.e. hedge funds have bid up the value of most assets around the world -- nothing is really cheap right now according to many smart folks so if the markets drop then all will drop -- no safe havens is the theory. That has largely been true this year except for a key exception -- Japan. The yen carry trade unwinds whenever stocks get smacked. Unwinding a Yen carry trade means investors buy Yen -- that leads to good returns for anyone with Yen assets -- like a Japanese equity fund. if you want to have some part of your portfolio up on the day the markets get whacked then please buy some Japan stocks.

the secular value investor portfolio is doing very well this year -- as of today I am outperforming the S&P 500 by over 800bps. That is due to large holdings in Asian funds up 40% this year plus a holding in energy stocks like the vanguard energy fund up a similar amount. some strong individual stocks this year such as NVT, GOOG, MMP, EPD, and a bunch more. in some ways I'm brilliant for having these exposures but in many ways I'm just in the right place at the right time -- I like growth and so does the market. You may have noticed that very few stocks are doing well right now -- if you don't own something like GOOG or CME or that ridiculous horse FLIR then your portfolio might be sad. Technology is huge -- a couple of months ago energy went on a huge tear. industrials, commodities, etc -- even utility stocks have been strong. narrow markets last longer than people expect but eventually that which is bid up gets dumped.

oil -- part of the increase is dollar driven -- priced in dollars world wide if the price of oil doesn't rise as the dollar falls then the price of oil is being effectively cut for most of the world -- can't have that given the current supply demand situation for oil so the price rises.

lots of talk about oil driven by geopolitical issues or speculation by hedge funds or whatever -- bottom line is that there is a shortage of oil. It will last until more oil is produced than is demanded. when will that be? who knows. I don't think it will be soon -- that's why I own CLB and other energy stocks (VGENX). It will take time to find oil and to set up production infrastructure, etc. finding the oil is the hard part -- production at existing wells declines each year which adds to the difficulty in really ramping up supply. supply is in ugly places that like to tax oil companies so that even at current prices it may not be worth it to drill for oil. that's why you see such large share buybacks at most of the large oil companies -- they find it hard to effectively spend any more on finding or producing more oil.

TSRA Q3 07

good report -- upside to revenues and earnings although guidance for Q4 and 2008 was somewhat confusing. The reality is that 08 is all about the litigation -- if they win the revenue growth is huge and if they don't the stock will collapse. odds of success are high -- similar court to previous victories, same issues, etc.

over next several months this will hopefully be a big winner -- could easily be $50 in 6 months.

Wednesday, October 31, 2007

latest thoughts

As you can see I spend lots of time coming up with titles for these notes -- today's is especially eloquent huh? NOT. Anyway, life around here has been busy -- on non-investing matters such as family. That is what is most important but it doesn't do much for you the reader. I'm going to be busy for the next few days too so I don't know that I will post again before the weekend.

Ok, so that took up most of the time I have available before work (employer blocks my access to my own blog! the nerve -- expecting me to actually do my work like that!) so I guess I will try to post again soon.

one quick thought -- DFR DCM deal -- great that they are going to try to renegotiate. would be bad if they don't do the deal -- externally managed REITs sell at lower valuations because investors understand the conflicts of interest and assume the worst (i.e. that management is not acting in the best interests of the REIT). Why hasn't the stock taken off post dividend announcement? because they have some flexibility to pay a big dividend once or twice -- people are likely waiting for the earnings to get a sense of future earnings power plus liquidity.

Thursday, October 25, 2007

earnings briefs III

So many reported in the last few days I'm going crazy. I will try to update thoughts now and then provide more thoughts over the next few days -- it will be hard because work is busy right now and the in-laws are in town so finding time to do research and blog posting should prove interesting -- there is always Sunday....

CME -- nice move in that stock huh? wow. Volumes were strong and rate per contract only fell a slight amount and expenses were only slightly higher -- that translates to 64% operating margins and an earnings upside. Deals with Brazilian and Korean exchanges could be nice additions. The key to korean part is taking advantage of the downtime in the systems -- Korean trades would be processed while we are asleep (well normal people anyway). Volumes are only up 14% so far in Q4 so growth rate will slow relative to Q3's huge rates but I am pretty sure everyone expected that. Merger integration should help volumes -- once CBOT is added to globex they should see some pick up in volume.

AB -- hedge fund performance fees as of June 30th were supposed to be enough to drive earnings around $1.8 in Q4 but instead they are going to earn close to $1.40. That is quite a drop and explains the drop in the stock Thursday. I'm a long term owner -- since 2001 so I'm used to the volatility of earnings. Hedge fund performance fees can be quite large (20% of 2006 Q4 revenues) but sometimes they are going to mess up performance and not earn the extra fees. asset flows from institutional clients are a little light of expectations but they have had strong growth the last year. Private client growth is most important -- 14% of assets now but they generate 28% of advisory revenues. asset growth in private client was very strong. they are very well position in terms of global assets (non-US clients now 39% of total AUM, non-US assets now 60% of total AUM) as well as private client and hedge funds. The price you pay for having strong probability of outperformance is some quarters they stink.

FLIR -- UGH!!!!! so much for the theory they might disappoint given how strong the stock has been prior to the report. Wow. up 14% is pretty darn good. Had the chance to buy some wednesday at $56-57 but didn't. That would have been sweet. Government revenues up 70% is huge. backlog is up $80 mill since June and almost all the backlog is in gov biz. Thermography accelerates to 21%, while commercial side is now 29% growth. To have overall revenue growth of 43% is awesome. Operating margins now reach 27% -- they are going to 30% its just a matter of time. most estimates assume a slowdown next year but that seems a stretch to me -- they have won a bunch of new contracts on the gov side and they have new product cycles in commercial and in thermography. definitely been way too timid about building this position. now I figure the best I can hope for is low $60's. Convinced of the long term picture more than ever -- unlikely to hose up a quarter in the next few either. will keep trying to buy more but man that $56 price sure looks good now!

GGG -- similar to last quarter in that revenues were light but earnings came in better than expected due to cost cutting and share repurchases. I don't like the fact that they are borrowing money to buy back shares. I am wondering how long it will be before the non-US housing related revenues are small enough that the fast growing non-US businesses can sustain high single digit revenue growth. its going to be awhile.

CLB -- don't have as much info yet -- other than they had good results. stock reacted to same level as first purchase. had the chance to buy in at $122 or so but didn't take it. wanted to leave some powder dry in case the stock kept falling. instead you had less than a day to buy it at those prices.

LH -- haven't seen the post call comments but so far it looks like UNH contract is pressuring prices and that is leading them to miss numbers. key question was why was 08 guidance assuming lower margins? not sure. could be conservatism or price competition. That means both of my lower multiple consistent growth stories (MDT LH) that are supposed to act as ballast vs. the high fliers like ILMN have disappointed this month. ouch. LH has shown consistent 7% free cash flow growth over the last 5 years. not many companies can say that -- many might have the revenue growth or the EPS growth but often something gets in the way of the FCF growth -- could be one year they grow huge and the next they see a decline in FCF. LH has seen consistent growth. that is one reason why I like the story. Still all things considered I would rather own more TECH than LH right now and that's very different from my actual holdings.

MSFT -- only number I needed to see was the 27% revenue growth. that's what matters. They beat estimates and raised guidance on 2008 all due to better revenues. not chump change but raising guidance by 1.5-2 bill or so. that's real money. stock was up 10% in AH trading.

that's it for now!

Wednesday, October 24, 2007

more briefs

GOOG -- great report last week. How many companies with a run rate around $17 bill in revenues are growing 57%? can't be too many. They own the most value added part of the web -- search and that's not going to change any time soon. So many keep asking what is the next thing after search -- the reality is search is good enough for them to reach several times their size now because its such a value added activity. Gadgets -- these new ad features are going to be a big deal. How does GOOG keep the growth going -- ad innovations like the Gadgets, which open up Google to a whole new set of advertisers. at some point will see operating leverage too -- they are choosing to grow op ex so quickly that margins drop. that will change at some point and earnings will grow faster than revenues. don't expect a sharp drop in the revenue growth number -- past history of tech suggests more of a gradual decline in the growth rate.
ILMN -- didn't get the chance to listen to the call -- will try to do that soon. The press release looked pretty darn good based on revenues and guidance. It is amazing the impact of the solexa gene analyzer. gross margins declined several hundred points from over 70% to low 60's due to the big mix shift towards instrument sales away from consumables. That also impacted accounts receivable (longer payments for big instruments vs. little consumables? makes sense to me) and cash flow. the stock was down as much as 8% in after hours tonight -- if that holds I will be buying more. The shift to instruments hurts this quarter's margins but longer term it just made their installed base and their available potential that much bigger. great story.
MDT -- JP Morgan out with comments today suggesting in another 6 months all will be forgotten and the stock will be materially higher. he makes some great points in that ICDs are only 21% of revenues while neurological, diabetes, spinal, etc are larger and growing faster. Those areas are more like 42% of sales. Its possible he is too optimistic on ICDs but even if he cuts them hard it only impacts 10 cents of earnings -- $3.15 in calendar 2009 instead of $3.25. This could easily be a low $60's stock 6 months from now. Trouble is I have thought that at each step of the way and yet something has gone wrong to cause the stock to be flat for 7 years. I cringe when I realize an average stock would have doubled over the same period with good stocks up 3-4X or more. I think there is a good chance he is right but its definitely a frustrating stock.

Monday, October 22, 2007

brief thoughts

DFR -- getting interesting again isn't it? one moment not sure they survive and then the next we figure all is fine and now we realize the truth is probably in the middle. given the hits the banks took on their portfolios and that thornburg took (TMA) that led to elimination of the dividend, I guess everything is back on the table at DFR -- meaning we can assume its possible they saw drop to book value as well as they may struggle to earn the dividend this quarter as well they might have sailed right through with no issues. we shall see -- dividend press release should come before earnings.

MDT -- key is to think about what they are likely to do in the future -- are they going to keep growing 15% on the earnings side over the next 3-5 years? unlikely -- but with the stock at 17X not many others believe either.

UEPS -- analyst downgraded last week saying the SA welfare win is already in the stock. maybe but seems to me that this stock could see higher 30's when it actually happens. 25X 08 estimates seems reasonable given that once the deal is announced they also have growth drivers in nigeria and with wage payment too. while welfare might not help 08, the 09 estimates should move up ward post deal.

FLIR -- SLB's drop post earnings explains why I haven't bought more since my last purchase at $53 -- expectations can get ahead of reality. FLIR has great momentum in their business now but they also have a lumpy government business which can cause them to come up short of expectations any quarter. that's the time to pounce because it is unlikely to last.

Bought more CLB on the fall in SLB. I got more at $132, which means I wasn't patient enough because it traded below $130. I don't think what hurt SLB impacts CLB and the drop takes some of the hot air out of the stock prior to earnings. is it likely to see more of a pullback post release -- quite possible. I think longer term my purchases will work out fine but there could be pain first. Everytime I think about the stock being up 13 fold since 2001 I remind myself this is still just a $3 bill market cap stock -- I could easily see them up 10 fold over the next several years.

20 years ago friday

I was in college in 1987 -- a sophomore to be exact and in an economics class when I first new that the market was dropping hard. My professor pointed it out at the start of class. I lost a fair amount in that drop -- made worse thanks to my exquisite timing of putting my remaining cash into the market at precisely the top in late August of that year.

The good news is that I knew immediately that it was done -- one of the shortest bear markets on record it only lasted a few months but I knew it was over. Had no doubt we would not repeat 1929. The bad news is that I didn't have any cash to put to work to take advantage of that thought. I also don't think I rearranged the portfolio in some magical way to take advantage of my bullishness. I did ok but I owned plenty of stinkers over the next few years.

sharp drop on Friday -- this one is earnings driven as people have decided the earnings won't be as good going forward. Not worried about financial crisis anymore but now worried about slowdown and margin compression. First on the slowdown -- sure some industries will slow or have slowed but overall we are not going to have a recession. the economic cycle research institute says so -- have yet to see them wrong in 7 years of forecasting so I give them the benefit until they are wrong.

On margin compression -- sure some industries will suck while others soar. I would argue against looking at the macro picture or trying to figure out the right margin level for the aggregate of corporate profits -- instead focus on individual companies. Case in point would be Friday's markets -- Google up while everything else is down 2.5%.

comments on some of my stocks to follow.

no I don't think we are going to crash on monday -- 100 years of markets and we have crashed twice. Its a low probability event that too many people are expecting. will we be down this week -- absolutely -- quite likely anyway. depends on the stock and their earnings.

Wednesday, October 17, 2007

Oceans

I read an interesting post today about Google -- here is the link:

http://seekingalpha.com/article/49892-google-vs-microsoft-blue-red-ocean-earnings-productivity?source=yahoo

and that led to an interesting article about something I had not heard of yet -- red vs. blue oceans:

http://www.insead.edu/alumni/newsletter/February2005/Interview.pdf

Like most corporate strategy type stuff the advice appears to be obvious common sense stuff but I think its very interesting and worth spending the time to read.

In the secular value investor's portfolio I can see blue oceans in:
Goog, ILMN, GGG, FLIR, UEPS, TSRA, CME, FDS -- now some of those are more accurate than others. I definitely agree with this blue ocean concept -- I would also carry it towards business models too -- almost every industry has at least one company that has figured out a way to earn good returns in that industry -- southwest airlines, landstar trucking, etc. These are companies that are able to earn very high unlevered returns on equity in industries known for average or below average profitability.

enjoy the reading -- let me know what you think

CLB

Yep -- I talk about it on Friday but did I buy? nope. then monday the stock pops $6!!!! ugh!!! I waited for the stock to be only up $5 and change and then bought about half the number of shares I originally intended. now its a waiting game for a pull back before buying more.

I did more reading and continue to like the story -- I don't have time tonight to cover precisely why I bought -- another day.

I'll let you know if I buy more.

Tuesday, October 16, 2007

MDT

I have owned MDT for about 6 years now with virtually nothing to show for it -- the opportunity cost of what I could have earned with that money in another stock or even a fund is staggering. I paid way too much for MDT back in 2001 -- I bought it on a pull back at 30X earnings -- that was on a pullback! MDT's PE, like a lot of other growth stocks at the time, had reached levels that were unsustainably high (vs. what they were actually able to earn).


MDT's revenues and earnings grew in the mid teens for a few years afterward -- until the last year or two when issues with slow ICD growth led to more like 10% revenue growth. share buybacks, lower tax rates, cost cutting, etc. have allowed EPS growth to remain in the mid teens. The PE has dropped to the point where now the stock sells for around 17X next year's numbers. So the stock is flat because the earnings have gone up but the PE has been cut in half.

This is a key risk for a growth stock -- the growth occurs but investors decide the future won't be as good as the past so the PE drops. That's why I stress valuation -- if the PE isn't high when you buy then the odds of you being hurt when the PE drops are less.

The latest news is that their leads on their ICDs are not functioning properly -- complications. the risk is that this is another reason for doc's not to refer patients for an ICD and MDT can no longer claim product superiority vs. BSX. I doubt its as bad as the 12% drop in the stock but then again the stock ran up on the news of endeavor (drug eluting stent) approval so really the stock is just back to where its been for about 7 years.....

MDT has always had a hold on me -- I just love the cool things they can do with technology inside your body. After every disapointment, I have usually thought there is too much potential with this company and too much quality in terms of the returns and the cash flow, etc. to not own it. a month or so ago in this blog I said I should look for replacement ideas. I haven't really but I should have. The trade was into TECH -- so far at least that one has held its gains unlike MDT's move to the mid-high 50's.

I'll keep searching for the right situation.

Friday, October 12, 2007

CLB

Core Labs is an oil services firm that has technologies to help oil companies get more energy out of their finds (reservoirs). I have just started reading about them but so far I am very impressed. I just wished I had heard of them a couple of years ago -- its been a great stock so far.

This is getting habit forming isn't it? After CME, ILMN, FLIR, GOOG, TECH, FDS, etc., I presume anyone reading would think I don't care about valuation nor fundamentals because I just chase the biggest winners. One look at DFR, UEPS and TSRA (average cost is $26) should help convince people its not true.

Anyway, I just keep trying to find stocks that meet my criteria and if it turns out that I miss a lot of appreciation there isn't much I can do about it. Just to recap -- here is what I am looking for in 3 easy steps:

1. must be a beneficiary of a powerful secular trend that should allow them to grow faster than the average stock even during slow economic times.

2. The company should be the cream of the crop -- one of the best scenarios is a company that sells the highest value added service/product in an industry that customers cannot do without. Examples would include Google, NVT, TECH, CME and maybe ILMN. Other possibilities are companies with large market shares (FLIR has 40% of commercial infrared) or specialized niches such as TSRA, UEPS, etc.

The company should be either very profitable or on its way there based on a strong competitive position. The company should produce lots of free cash flow -- which should be a similar or higher amount as reported net income. Last, management must act rationally and in a shareholder's best interest -- their cash flow should be intelligently allocated towards good cap ex projects, acquisitions that make economic sense and or returning the money back to shareholders through dividends and share buybacks.

3. stock's valuation should be reasonable -- the more attractive the better relative to what the firm is likely to earn in a few years. The stock might appear expensive on several measures but it could still be cheap relative to what future earnings will be -- so FLIR looks expensive at current 30x 08 estimates of $2 but they might earn $6 in 2013 and sell for $150+ in 2012 (5 years out) -- that would be a pretty good return relative to most other stocks (of course it may not work out that well either so we would have to risk adjust that $150).

So how does CLB do on the 3 steps:

1. energy is a great secular theme now -- basically both supply and demand are being impacted to create rising prices. Demand is from strong global economic growth. Supply is impacted by aging fields and the difficulty finding new fields that are large enough to meet rising demand.

2. CLB provides reservoir description services which help oil companies understand precisely the shape and chemical make up (oil, natural gas, water) of the reservoir. Oil companies use this info to determine how to use their drilling equipment to extract more oil/natural gas from the reservoir -- about an extra 5-10% of the volume in the reservoir. Boosting production of existing wells is a high return and low risk investment so this fits the high value add of the industry. They have over 20% operating margins with incremental margins of 50% (the margin on the revenue growth for the period) so they meet the profitability test. As mostly a service company with some technology products too they have low capital needs so lots of free cash flow. Management has bought back between 1/4 and 1/3 of the shares outstanding over the last few years -- their stated policy is to return all free cash flow to shareholders through buybacks.

3. valuation -- its expensive vs. history and vs. other oil services companies at 22X 08 estimates. The stock is up about $30 since July. I expect revenues to continue growing the low teens and for operating margins to continue to expand each year. use fewer shares due to the buyback and EPS growth should be closer to 20%. Buying 20% growth for 22X is cheap -- but then again oil services is cyclical so they will probably only grow that fast in an up cycle. I expect energy companies to grow their spending on both finding and producing more oil for years to come -- they are not keeping up with demand yet.

Management appears to guide about 10% less than they actually end up earning so my hope is that the valuation is not as expensive as it first appears. I expect with incremental margins continuing to be well above current margin levels that those margins will be going up for some time.

For me its about position size (small until theres a pull back) and reducing my exposure to energy since this one is definitely a more volatile choice then my current energy stocks.

I'm still learning the story so I know my explanation does not do it justice but I hope to improve your understanding of this story over time.

Thursday, October 11, 2007

market

Can't explain today's action -- market was down and my portfolio was up -- worked out to be almost 1% outperformance, which is an unusually high level. Stocks like FDS, ILMN, GOOG, FLIR and others all had good days with many reaching all time highs!

The whole market looks like a V bottom just like it did in 1998. that doesn't happen often -- check out the chart on GS -- from $230 in July to $160 in August and then $230 again in October. would seem natural that we would pause here around the highs (resistance) after such a sharp move down and up from July to October. Then again -- too many people buying puts (possibly betting on decline but more likely buying insurance against a decline so that they don't have to sell their equity exposure).

Its frustrating because you look at stocks like FLIR and ILMN and its too easy to beat yourself up for not owning more of them -- why didn't I read about ILMN's analyst day sooner -- I looked at their slides and decided I should have more of the stock but I still haven't bought in because its moved up like 20% in the last week or two. Apparently I wasn't the only one that heard what they had to say and thought they needed to buy more of the stock.

FLIR is a great long term story -- they are a good story for the next year but they are growing like 20% or so -- its not a 100% grower like ILMN has been. I don't expect estimates to fly higher after FLIR reports so why chase the stock now? I just don't want to do it because experience has taught me that I'll get a better chance. Then again we have been in a value market for years -- you get chances in that kind of market. In a growth market often times the stocks just go up and that's it. by the time the pull back happens the stock is so much higher than you wanted to buy it that you can't stomach the idea of buying even on a pullback.

The pullback's are also often short and shallow -- so I buy FLIR first at $49.75 and then again at $53.75 on a pullback but I didn't buy again at $56 the next pull back price and I'm kicking myself for not buying a bunch under $50. today it closed over $59. short, shallow and higher than you want. If you have any discipline, this market makes it difficult. It won't last forever but it will certainly try my patience. In the meantime, I'm making money so this might sound like complaining but its definitely not complaining.

UEPS -- Morgan Stanley Africa visit

I know that wall street analysts don't have the best reputations but I read their notes when I am able and I use them as part of my process -- that is the key -- how you make use of them. The one risk I would highlight from the top of my lungs -- never ever EVER pay attention to an analysts rating -- all kinds of reasons why an analyst has a rating but only sometimes is it because the analyst thinks the stock in question is going up or will outperform.

But many analysts have great industry contacts and spend a lot of their time doing the arduous legwork of calling customers, suppliers and competitors of the companies they follow to gain insights into a company's demand, market share trends and likely margins. why not pay attention to that kind of data?

Today Morgan Stanley wrote about their visit to Africa -- it was a very interesting report because he talked first hand not only with UEPS management but also with All Pay's (competitor to UEPS) as well as government officials. I can't go to Africa nor do I want to call these people on the phone. MS going there in person has got to provide valuable insights.

Key highlights:

1. expects SA welfare contracts to be announced by end of November -- that should remove a lot of uncertainty from the story -- and he expects that they will retain their current business and pick up an additional 500k to 1 million new welfare recipients as they win contracts in 2 other areas of the country. After talking with all sides, he does not believe UEPS has heavily discounted the price. They sell at a 10-15% premium to all pay but they also are mostly rural whereas All Pay is mostly cities. The two areas MS thinks will be won include one rural area handled by some one else right now that has mismanaged the job -- fraud and everything. The other area is currently split 2/3 UEPS and 1/3 all pay -- only one winner per area so in this case UEPS takes the rest.

2. He also talks about UEPS winning a technology administration deal in SA that could add 20% to current earnings estimates.

3. just working out the details on Nigeria and wage payment in SA -- in the case of wage payments the goal is 1.5 mill new cardholders in the next 3 years (around 4 mill cards in total right now so 1.5 mill is a big jump). Nigeria's economy is 95% cash and their population is 3X the size of SA -- UEPS is likely to gain millions of new cardholders over the next few years. He goes into details about how in nigeria they are lined up with a major bank while the rest of the banking industry is watching -- if the early results are good, then expect other deals with many other banks to rapidly increase distribution and the number of cards outstanding.

4. still working on winning other countries. Plus they are still working on perfecting their virtual credit card (one time use credit card numbers) business -- the technology works its more lining up partners and determining the business model. This tech allows you to make credit card purchases over the phone or over the Internet with the money coming out of your UEPS account. The MS analyst calls this a killer app technology -- they are excited about it.

I know I have gone on and on about FLIR lately, but this is still the biggest opportunity. If this story works then the stock could easly reach $80 to $100 over the next 3-5 years. The earnings potential of this company is huge.

Tuesday, October 9, 2007

AB -- till death do us part

I'm a long term owner of Alliance Bernstein -- pretty much married to that position so keep that in mind when you read the rest of these comments. They announced their assets for the month of September today and made a comment on the performance of their funds.

First, a reminder on why I own this or any other money manager -- if their assets are mostly equities, then their growth is equal to the market's return plus or minus fund flows in or out of the funds. If you pick a good manager to own, then over time their fund flows should be positive and that means faster growth than the market -- a simple path to outperformance.

Next, the good news is that AB's assets were up about 4% in September (revenues = assets X per asset fee). The not so good news was that Alliance lost $6 bill in index/structured products to competitors -- but keep in mind that the 4% growth includes that $6 bill loss so they were able to offset it with growth from elsewhere. Plus index products have some of the lowest fees so from a revenue standpoint its unlikely the company will notice the loss.

The bad news is that they said hedge fund performance was poor during the quarter -- Alliance relies on quant methods for a lot of their products so its possible the troubles quant funds had in August impacted them. Hedge fund performance fees have a big impact on Q4 earnings -- last year's Q4 represented almost 40% of the entire year's earnings and all of the extra income was due to hedge fund performance fees (that 20% of the profits thing). I expected this year to represent a similar percentage of the year's earnings. In Q2 they had said hedge fund performance was exceptionally good so its possible they are still good for the year. We will have to wait until the earnings call on the 25th to get the company's latest guidance on Q4 results.

Since Alliance is a MLP, my taxes are more complicated each year but they would be very complicated if I ever sold my shares. The lower performance fees is a near term negative but I still think AB can earn close to $6 next year -- their dividends equal their earnings so that means more than a 6% yield. its a bargain to me -- great growth, strong yield at a reasonable price.

Saturday, October 6, 2007

Giddy

As I have mentioned before, control of emotions is important for investment success -- emotions can often make us do irrational things such as buying at the top (greed) and selling at the bottom (fear). Your best gains come from doing the opposite -- trimming when others are greedy and buying when others are fearful. When the markets are running higher, I find myself feeling giddy with excitement -- that's my drug -- no other feeling like making money from the right stock calls.

With the portfolio up over 16% (4.95% better than the S&P 500) this year its an exciting time. I was re-reading what I said at the bottom in August and I would give myself a mixed review. I correctly nailed the bottom with a note published late Thursday night (the 16th of August) prior to the discount rate cut the next morning. But I referred to a short term bottom -- not THE bottom before a huge rally in the market. I wasn't pounding the table and that was wrong.

DFR -- now up to 10.26 -- over a $1 above where I trimmed for risk purposes. I'm not upset about that -- the stock was too much of my portfolio and its daily ups and downs was bothering me -- that's the sign its too big. Once they report Q3 earnings I would expect one of two things will happen:

they will either have no issues with their book value and will declare the same dividend and talk about growing the dividend over time in which case the stock will work its way up to the mid teens OR their book value will take a hit due to credit losses or mortgage pricing issues (leverage) and the stock will stay around 1X book value at most. Right now if I had to bet it would be that the stock makes the mid teens but again -- that comment is made during a moment of giddiness -- probably won't be as good just like it wasn't as bad as I was thinking when I was writing notes wondering if they would survive back in August.

Will need to do some more writing on Illumina soon -- they had an analyst day a month ago and I have just gotten around to doing some reading about it. They talked about offering genetic data on individuals for $1000 in a deal with 23 and me (google founder's wife's start up). That could be interesting. The good news for ILMN is that the desire for genetic research is infinite -- there is no limit to the number of studies that would be conducted if funds were available. That is the limit to their growth -- fund availability. As the cost of sequencing a human genome drops from millions to thousands, volume will soar but in the end there are only so many dollars available unless they can access other pools of money beyond research budgets like consumers (23 and me) and diagnostics. Keep in mind when you look at the published valuations that its not as bad as it looks -- their free cash flow is pretty darn good -- usually well in excess of the earnings numbers people use to value them.

CME -- stock has had a great run -- turns out the day after I last bought some, the B of A analyst put out a report explaining that there was no sign of hedge funds reducing their leverage or use of derivatives. Stock has taken off ever since. Apparently many investors were concerned that investors were deleveraging and that meant fewer derivatives. so far no sign of that. I would keep in mind the huge growth opportunity at the CME is the switch from OTC to exchanges. Over the counter trades in currencies and interest rate swaps are many many times larger than those done on exchanges. OTC provides flexibility in setting terms of derivative but exchanges provide greater liquidity and less counter party risk (risk the other side won't live up to terms of the trade).

Personally I think the industry trend towards greater use of leverage to generate higher returns for clients is a scary one -- leverage comes in multiple forms but in this case I mean new 130/30 funds where a manager goes short their worst names using 30% of the fund's capital and then redeploys that money into their favorite names (i.e. the 130 part) . goal is to earn a higher return, while having the short side maintain same risk profile. It won't work as well as they think -- they are back testing it on periods where there wasn't as much short interest and therefore once you add all this new shorting capacity the markets will change. Other forms of leverage include greater use of derivatives, which are leveraged securities. I am not as worried about a system failure as I am investors dramatically increasing their chances for being wiped out or losing much higher percentages of their wealth than they thought possible. At some point this might be a risk to CME's growth but in the meantime they are a huge beneficiary.

So back to being Giddy -- wouldn't be surprised if we have a pullback soon -- things have run quite a bit here so a rest is in order. still bullish longer term but a rest is ok.

Thursday, October 4, 2007

400 bps

The secular value investor's portfolio is now outperforming the S&P 500 by 400bps (I'm up 14% while the market is up 10%.). helpful positions include NVT, ILMN, AB, Asia, Energy, Goog, CME, etc.


Some keep wondering about the disconnect between a record setting market and the expected slow down in the economy and the risk that brings to corporate profits. First point to keep in mind is that the best performers right now -- what is driving the indicies upward is a select few stocks -- mostly the secular growers like CME, GOOG, AAPL, FLIR, etc.

These are stocks that have a reason to grow even in weak economies. They generally have large international revenues. Their stocks have been flat or have dipped at some point over the last couple of years -- so they haven't necessarily been the best performers all the time (think about GOOG and CME spending lots of time in the low to mid 500's, look at NVT and ILMN last spring, etc.) Their valuations are high but going higher as various types of growth investors bid them up on the theory that there aren't any other choices so they must bid these up.

Its not true -- what is ugly today can become a swan tomorrow and what is a perfect stock today can become ugly tomorrow -- keep that in mind as the market takes off. AFFX is my reminder -- I bought in around the low $30's and within a year the stock was nearly $60. Then a competitor came along and their success took all the revenues straight from AFFX -- a few earnings misses later and I sold AFFX around $30ish. its in the 20's now -- still. So rather than a double I ended up round tripping -- perhaps now you understand why I have chosen to take profits in NVT and ILMN this year.

So called growth stocks do best when economic growth is decelerating because they can grow and the cyclical stocks can't.

If we get any sort of reacceleration in the economy, we will see the cyclicals take off again.

To the extent that my portfolio is invested in the secular growers, my performance will be great. these types of markets are great fun for my strategy -- but eventually these stocks will go up too much and then pull back hard -- its best to keep an even keel about performance but I find that hard to do. The roller coaster is where I live -- happy when I am right and sad when I am wrong.

Wednesday, October 3, 2007

TSRA

Quarter preview -- units are doing better than expected so that means Q4 guidance (remember the 1 quarter delay in their results) should be a little better than expected. no other catalysts unless they announce a new customer for micro pilr or digital optics -- that would be important.

Cowen out a month or so ago saying $3 in earnings potential in 2009. I think his operating margin assumptions (over 70%) were a bit unrealistic. My numbers would suggest the following:

2009 EPS estimate -- figuring 2 cents per unit and 80% share of units shipped gets you about $300 mill for the base CSP business assuming around 19 bill units in total (19 X .80 X .02). Add in about $40 million in service revenue plus something for the new optics business/micro pilr -- say $40 mill gets you total revenues of $380 mill. Figure about 50-60% operating margin (last company guidance is 50% although at that revenue level operating margins could be closer to 60% due to operating leverage) plus 40% tax rate and around 50 million in shares gets you EPS of around.... $2.50. That's not counting stock option expenses (I look at cash flow and stock options are non-cash).

Maybe they will be able to do $3 but its a good bargain at $2.50 so why push the numbers?

Put a 25X PE and add back in a few dollars in cash on the balance sheet and the stock could easily be in the mid to high $60's based on 2009 estimates. When? could be a year from now to 18 months when 09 is discounted in the stock. up about 70% in 12-18 months is pretty darn good.

The question is can you stomach the volatility? Its a great long term story but no obvious reason to own until late Q1 of next year. I have a strong stomach but that might not be true of everyone. have to keep your eyes on the longer term prize and not worry so much about the gyrations in between. Figure in 2010, the revenues could be between $450 and $500 mill. Do the math on earnings and you get over $3. Stock could reach $80 in 2-3 years.

There is plenty that can go wrong -- micro pilr doesn't expand market nor hold on to largest customers post license expiration. unit growth may not materialize due to a recession or slow down in wireless and DDR2 DRAM unit growth.

I think the odds of success are in our favor. That's why this is one of my largest holdings.

DFR

a money manager was interviewed on the street.com about DFR -- he said he has spoken to management and he feels the dividend will continue at the current rate. No idea how credible he is or just how much info they provided him -- their dividend press release is probably 3 weeks away. Yes quite possible that dividend will continue at current rate -- also possible we could see a cut due to credit losses on the high yield portion of the portfolio or trading losses on the mortgage side (liquidity raising could have had costs) or because their book value dropped due to price declines in mortgages they may decide to conserve cash.

Still a little craziness in the credit market - LIBOR rates have dropped relative to fed funds but last I checked (a few days ago) they were not back to normal yet. that suggests liquidity in short term markets still not right yet but commercial paper has been fixed.

but the yield curve has steepened -- usually that is a good thing for a mortgage REIT but in DFR's case they have quite a few interest rate hedges so its not straightforward. I do remember them saying during the Q2 call that the yield curve steepening then was adding to their margins and the curve has continued to steepen since then.

with credit spreads widening and the yield curve steepening the overall profitability of the portfolio should be getting some help to offset any pressures mentioned above. If those pressures didn't hurt, then there is an excellent chance they should be able to reach their high teens dividend yield on a $15 stock price (i.e. a 2.50 type dividend) in a few years. Trouble with liquidity issues -- they raise the risk of total loss to be too high to really take advantage of the price decline in the stock yet if the liquidity issues fade and the company survives, we all feel like idiots for not buying at the bottom. You have to fight that feeling because the risks were too high to put money in at the bottom in this case -- that is normally not true but here it was. Liquidity risks are too tough unless you have more intimate knowledge of the repo/mortgage markets (i.e. trading conditions) than I had at the time.

Q3 dividend and earnings should be quite interesting.

Tuesday, October 2, 2007

Wow

What a day! Up 1.5% today in the portfolio yet NVT -- a big winner this year is taken out this morning thanks to Nokia and yet we lose money on it today? Deal was for same price as Friday close so the stock had to drop because in 4-6 months its STILL going to only be worth $78 unless the deal doesn't go through (unlikely) or another bidder comes along (also unlikely).

I am hopeful that today's drop is enough to create a risk arbitrage return -- meaning it won't have to drop any more. I should have sold mine at $77 but I was too slow to do the math and realize that was a good price. its effectively cash now. What to do with it?

As you can imagine, my first thought was to buy more FLIR -- apparently I wasn't the only one with that thought since the stock was up 7% today!

I am hoping patience is a virtue but so far its been wrong.

Too many people have been fighting this market up - they just haven't believed in a rally given all that is going on in housing and so forth. So once we get to the point where everyone is accepting the rally -- that's when we will get the pull back.

Today's news was positive in that various financial firms are recognizing losses -- this does 2 things. It puts a size to the problem so now investors have some idea how big an issue fixed income losses are for the firm. Second, it allows the firm to start selling the bad assets and to try to get good prices for them -- now that the assets have been written down the pressure is off -- no more need to justify a price that isn't sustainable. The companies are now free to sell some of the assets with some patience (don't have to hold a fire sale).

Probably helps DFR but notice that stock was down 1% today. Big winners are the secular growth stories such as FLIR, CME, AAPL types as well as others. Many expect growth to become harder due to a slowing economy -- that means secular growers get big premium valuations. I think that is one reason FLIR and CME are going up.

I like FLIR but valuation is important too -- love the company but like the stock.

Trick then is to buy the secular growers when others are doubting them -- just like people were doing with NVT in the spring and with FLIR last year.

will keep an eye on various stocks including ESE -- Esco Tech -- sells automated meter equipment for utilities to automate meter reading. stock has pulled back due to missing estimates or lowering guidance. don't know much about it yet but will do some more reading.

lots happening with GOOG but its getting reflected in the stock and its too late tonight to discuss it.

Saturday, September 29, 2007

new look

any thoughts? Hopefully you have noticed the new look -- I like it better but if you have any thoughts please let me know.

I have changed the ads too -- there used to be 2 adsense buttons but now I have added 2 referrals areas -- these appear to get higher quality ads which is nice. let me know if the advertising becomes too much and I'll cut it back. its on the side so I am hoping its not so bad.

feedback would be great -- since its now almost 3:40am -- probably hitting bed soon.

update on stocks not bought

Over the last couple of months I researched many many stocks and commented on most of them here in the blog -- I even wrote up long descriptions of why I liked the stocks and probably made it sound like I was either buying or about to be buying them. Instead, most of the time, I would just move on to the next story and not buy anything -- until I got to FLIR. Which I have bought a small position in and am hoping to buy more at more attractive prices.

One of the first stocks I reviewed was Ecolab (ECL) -- it was in the low $40s and selling at a discounted valuation vs. its history. fundamentals seemed fine so this looked like a good time to get in -- no real catalyst that could get the stock moving soon but often its hard to spot them ahead of time -- hard enough to pick a winner let alone picking the timing of it.

Sure enough ECL is now $47 -- new all time highs and up from a recent low around $41. Not bad for a few weeks work. Not uncommon either for me to have a strong return in a stock I have chosen not to buy. that's one reason I mention them all -- perhaps the story will sound interesting to you and after your own due diligence, you might decide its more attractive then I give the stock credit for and choose to buy in. great for you. I can't own them all. I am very happy with FLIR but it would be nice to own some ECL too -- now it dawns on me that maybe ECL would have been a better choice than GGG given all the icky news about housing but oh well.

Interesting that ADBE -- another stock I have mentioned but did not buy -- had great earnings yet the stock has been flat to down since I mentioned it -- hmmm.... as the chartists say its not the news that matters but the market's reaction (it seems the market expected good results).

IHS had great earnings and the stock popped from the low $50's to the $57 range. Not bad. again, I am very happy with FLIR.

Ralph Wanger Lunch

I had the privilege this week of having lunch with Ralph Wanger (former manager of the Acorn fund and member Morningstar investor hall of fame) ... well it was me, Ralph and 100 other close friends! You can see Ralph's influence on my portfolio in several stocks -- UEPS, NVT, ILMN, FLIR as well as some not so obvious choices like GOOG.

Ralph was a small cap manager because he thought small caps had the best growth opportunities (true) and were the least followed or least efficiently understood by wall street -- meaning you had the best chance to outperform benchmarks, while investing in small caps. He used a strategy often called GARP -- growth at a reasonable price although in the end he would rather focus on value then growth -- value reduced risk and increased returns.

He has written a book called a Zebra in Lion Country, which I would highly recommend to anyone interested in investing in stocks -- especially small caps. Ralph is unusual in the investing world because he is so funny -- while I didn't learn too much new at the lunch that wasn't in his book or other things I have read about him, it was well worth it because of how funny he was.

He is also humble -- at lunch I asked him the question what steps he took to try to avoid large declines in small cap growth stocks (a common problem because when a company misses their stock often declines 30% or more in a single day due to the lower liquidity and higher company risk within small cap stocks) and his response included the comment that of all the analysts and portfolio managers at his firm, he had recommended the highest number of stocks with big declines -- something he could get away with because it was his firm and because his winners were more important.

He explained how small cap stocks is a winners game -- slugging percentage matters. Your home runs offset your strike outs. He mentioned IGT -- slot machine maker as a stock his fund made 100 times its money in. wow -- that is a home run I would like to hit!. Best I have done is MSFT or about 14X my money. (if I had not been stupid in 1999 and sold my shares of BEN, I would have a 25X gain on my first shares and a 10X gain on my average cost but alas I sold.....)

Ralph uses secular themes to manage his fund -- he said turnover costs for a small cap fund are so high due to the price impact when you try to buy and sell small cap stocks. He would try to keep turnover around 20% -- equates to a 5 year holding period on average -- to minimize trading costs. No one can predict a company's earnings a few quarters out let alone 5 years! So he uses themes as a way of identifying stocks that he can be comfortable owning for 5 years and still be reasonably confident they will have good earnings growth over that time.

One of his themes he mentioned at lunch that was really interesting was to avoid technology companies themselves but instead target users or beneficiaries of technology such as IGT.

IGT buys microprocessors from some tech company for $40 -- that semi company makes $10+ in gross profits on that chip sale. IGT takes the chip and adds other stuff to create a $2000 cost slot machine, which they sell to a casino for $8000 or about $6000 in gross profits -- great business. But the casino buys the slot machine, puts it on the floor and makes $300 per day from gamblers who are bad at mathematics. That means the casino has a 3 month payback on that slot machine -- that's why there are so many casino operators on the Forbes 400.

One other interesting comment he made during lunch was how does he spend his time between existing holdings and new ideas. He said they have a database of stocks covering all the small cap stocks they could buy. For each stock they have an estimated future return potential based on a growth estimate and the valuation. He argued to look at the outliers -- the stocks that looked the most attractive were most likely using estimates that were too optimistic while the stocks that looked the least attractive were likely using estimates that were too pessimistic. Everything in the middle was probably fine -- if you owned them, then leave them alone because they are doing ok. If you didn't own a stock in the middle, it was probably fairly priced so not the best opportunity. That's a great idea although its not one that I have used I think it would be a great way to help with your time.

He didn't really answer the question of what themes he is playing now other than to say energy looks good -- thanks for that tip! not unexpected given that many managers like to keep their cards close to their vest -- why give away good investment ideas for free? one of his firms top holdings? number 12 is FLIR.