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


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

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

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


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


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


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


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


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


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.


a money manager was interviewed on the 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


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.